Lower investment compared with the pre-crisis period is a bit of a puzzle. To a certain extent it reflects an appropriate decline in investment (especially in real estate), making a return to pre-crisis levels of investment neither appropriate nor necessary. But even taking this into account, the decline in investment seems excessive. And nearly a decade after the Asian crisis, the decline can no longer be attributed to transitional difficulties such as the need for corporations to restructure. Rather, there seems to be some evidence that corporations are responding to increased risks, notably to the higher volatility of exports and output.

Lower investment compared with the pre-crisis period is a bit of a puzzle. To a certain extent it reflects an appropriate decline in investment (especially in real estate), making a return to pre-crisis levels of investment neither appropriate nor necessary. But even taking this into account, the decline in investment seems excessive. And nearly a decade after the Asian crisis, the decline can no longer be attributed to transitional difficulties such as the need for corporations to restructure. Rather, there seems to be some evidence that corporations are responding to increased risks, notably to the higher volatility of exports and output.


Saving and Investment in Emerging Asia1

(In percent of GDP)

Sources: IMF, WEO database; and staff estimates.1 Excludes China

An active debate surrounds whether the emergence of large current-account surpluses in Asia since the 1997 financial crisis reflects an investment slump or a savings glut.1 A simple examination of the data suggests that it is the former: except in China, where both saving and investment have been rising, saving has been broadly stable whereas investment has declined sharply by about 9½ percentage points of GDP compared to the pre-crisis peak, and has remained near post-crisis lows. The underlying reality is of course more complex, and both the “investment slump” and “savings glut” points of view have adherents.2

This chapter examines the evidence in favor of an investment slump. In particular, it analyzes the investment decline and reviews possible underlying causes. It also discusses the outlook for investment, and offers a few tentative policy implications.

The evidence suggests that continued sound macroeconomic policies, along with microeconomic policies aimed at addressing structural sources of risk, could help to improve the investment environment and thereby support capital spending. At the same time, if heightened risk has supported precautionary savings, such steps could also lead households and corporations to reduce saving. Thus, from both the saving and investment sides, addressing factors that may have restrained investment could contribute to reducing Asia’s current-account imbalance.

Aggregate Saving and Investment

Emerging Asia’s investment decline has been prolonged, sizeable, and broad-based, reflecting a fall in private investment. For example, comparing 1992–96 with 2000–04, private investment declined by between 5 to 18 percentage points of GDP in Hong Kong SAR, Korea, Singapore, Malaysia, and Thailand. By contrast, public investment has in general been relatively stable.

Asia’s investment decline has been severe compared with those in other regions during the past 15 years. At various times since the early 1990s, Latin America, central and eastern Europe, and the G-7 countries as a group have experienced comparatively mild investment declines. Of course, during this time period, none of those regions underwent a crisis as disruptive as Asia’s; indeed, the Asian decline looks more similar to the decline in Latin America during the 1980s debt crisis. While investment recovered more rapidly in Latin America than in Asia, this mainly reflected an unsustainable inflationary expansion in Brazil; in Argentina, Mexico, and Colombia, investment remained weak into the 1990s.


Gross Fixed Investment

(In percent of GDP)

Source: IMF, WEO database.1Excludes China.

Investment Around Regional Crises1

(In percent of GDP)

Source: IMF, WEO database.1 Relative to peak; T=1995 for Emerging Asia, 1980 for Latin America.2PPP-weighted average of Argentina, Brazil, Colombia, Mexico and Venezuela.

The investment downturn in Asia partly reflected a collapse in real estate spending following a boom. By the mid-1990s, signs of overheating in construction were evident in several countries, with occupancy rates falling, real estate lending expanding rapidly, and property prices buoyant. Starting in 1997, however, construction investment fell quite sharply in these countries, declining for example by 10 percentage points of GDP in Thailand. Real estate prices plummeted in tandem, as the boom in real-estate lending turned into a contraction.


Selected Countries: Housing Price Index


Source: CEIC Data Company Ltd.

At the same time, equipment investment was also an important source of both the contraction during the crisis and the post-crisis sluggishness in various countries, particularly in Singapore, Thailand, Korea, and the Philippines. In Thailand, for example, equipment and construction were equally responsible for the post-crisis fall in investment. In Korea, facilities investment fell by half from its 1996 peak of 14 percent of GDP and has remained sluggish in recent years, whereas construction investment has recently been staging a modest recovery.


Selected Asian Countries: Real Investment1

(In percent of real GDP)

Sources: CEIC Data Company Ltd; and IMF, World Economic Outlook.1 Comprises Korea, Singapore, Taiwan Province of China, Philippines and Thailand.

It is difficult, if not impossible, to say whether investment is now at the “right” level. The bursting of real-estate price bubbles, and more generally the pruning of overinvestment, has undoubtedly brought investment down to more rational levels in several countries (consistent with the hypothesis of overinvestment, the run-up before the crisis was rather sharp in Asia, even compared with that in Latin America). In addition, while the investment rate in Asia is below pre-crisis levels, it has remained above those in other regions. Finally, a fall in the relative price of investment goods, and an improvement in their efficiency, could have reduced capital investment—though this effect appears to be quite small. (Indeed, the ratio of equipment spending to GDP has fallen by almost 4 percentage points of GDP in real terms since the crisis (Box 11).)

That said, investment does seem to be lower than macroeconomic fundamentals would suggest. For example, the relationship between exports and investment, and also between profits and investment, seems to have broken down since the crisis. The gap is particularly striking in the past few years: exports and profits have surged, but investment has not followed. In addition, the correlation between the investment ratio and lagged growth—a type of simple “accelerator” relationship—fell sharply following the crisis. Meanwhile, with Asia’s ICOR now around 4.7 percent, trend growth of (say) 6 percent would imply an investment/GDP ratio of roughly 28 percent, a few percentage points above levels prevailing in this decade.


Emerging Asia: Investment, Export and GDP

(Constant prices, 1986=100)

Source: IMF, World Economic Outlook.1Excludes China.

Emerging Asia: Investment and GDP Growth1

Sources: IMF, WEO database; and staff estimates.1 Excludes China.

Recent research studies also find that investment is lower than expected. Chinn and Ito (2005) find that investment in emerging Asia excluding China is much lower than predicted by their empirical model, especially in recent years (saving is also lower than predicted). Eichengreen (2006) finds that the sharp fall in investment cannot be explained by changes in fundamentals. In the IMF World Economic Outlook (2005, Chapter II, page 106), an empirical model fails to predict the drop in investment in emerging markets, and particularly in East Asia. In addition, IMF (2005) presents tentative evidence that investment rates in Asian countries are below long run steady state levels, even in countries where the capital/output ratio is below the steady state level and thus (in theory) investment should exceed steady state rates. In sum, the level of investment presents a puzzle.

What Might Have Caused the Investment Decline?

This section examines several possible reasons why investment has been lower than expected. In particular, it considers whether financial and corporate sector restructuring, competition from China, and a riskier investment environment may be adversely affecting investment in Asia. The increase in risk seems pervasive, whereas the other factors are more country-specific.

Financial and Corporate Sector Restructuring

Financial and corporate-sector stresses and subsequent restructuring aggravated the sharp decline in investment following the financial crisis, but these factors no longer seem to restrain investment. In the financial sector, the sharp deterioration in banking-system solvency and liquidity in the wake of the crisis caused banks to rein in credit, with sizeable repercussions for investment. The impact was particularly severe because corporate bond markets—which serve as an important backstop to bank lending during periods of financial stress—were underdeveloped. More recently, banking system performance has improved significantly, with nonperforming loan ratios down substantially (albeit generally above developed-country levels), regulatory capital ratios higher than before, and return on assets improved.3 Finally, in some countries a recovery in real estate prices has helped to take pressure off bank balance sheets. Accordingly, financial system weaknesses are much less of a constraint on investment than in the past. While credit to the private sector as a share of GDP has stagnated since the crisis,4 low lending rates suggest that this reflects weak corporate demand for funds more than difficulties in banking systems.5 Indeed, consumer lending has been expanding sharply in recent years (Box 5).


Emerging Asia: Bank Nonperforming Loans1

(Ratio to total loans)

Sources: IMF, Global Financial Stability Report; and country authorities.1 Excludes China.2Australia, Japan and the United States.3Philippines shows average of 1999-2000. 2005 data are for Q2.

Emerging Asia: Financial Sector Indicators1

Source: IMF, International Financial Statistics.1 Excludes China.2Excludes Taiwan POC.

In the corporate sector, balance sheets and profits have improved considerably since the crisis.6 During the crisis, leverage soared (partly due to currency depreciation); interest coverage and return on equity plunged.7 Subsequently, firms retrenched investment sharply as they rebuilt their balance sheets and restructured their operations. In recent years, however, leverage has returned to around pre-crisis levels, interest coverage has risen to the highest levels in over a decade, and profitability has returned to around pre-crisis levels—indeed, for the ASEAN-4 plus Korea, it significantly exceeds such levels (although for these countries, leverage remains higher than in the rest of the region, while interest coverage remains lower). These data suggest that emerging Asian corporates have adopted a fairly conservative financial stance, perhaps due to the aforementioned increased risk in the environment (this conservative financial stance could partly explain the low level of credit spreads).8 It could also reflect corporate governance considerations; that is, low leverage and high liquidity may reflect preparedness to buy back shares or take other measures to fend off the increased risk of takeovers. In sum, with corporate balance sheets at least as strong as in the early 1990s, corporate-sector weaknesses seem unlikely to be responsible for holding back investment at a regional level.


Emerging Asia: Return on Equity1

(In percent)

Source: IMF, Corporate Vulnerability Utility.1 Excludes China.

Emerging Asia: Interest Coverage Ratio1

(In percent)

Source: IMF, Corporate Vulnerability Utility.1 Excludes China.

This broad picture masks pockets of weakness in the corporate sector, however. For example, the data analyzed above include only listed firms, and thus exclude many small and medium-sized enterprises (SMEs) whose weaknesses have been an important drag on investment in some countries—most notably Korea (see Chapter III of the August 2005 Asia-Pacific Regional Outlook). In addition, the bursting of the global IT bubble early in this decade had a serious adverse effect on technology firms, at the same time that they faced heightened global competition. Relatedly, China may be drawing investment away from other countries in emerging Asia, a topic that is discussed next.

Competition from China

China’s considerable success in attracting FDI has raised the question of whether this success might be coming at the expense of other countries. Direct investment flows into China have risen by around tenfold since the early 1990s, making it one of the world’s top destinations for FDI.


Emerging Asia: Gross Foreign Direct Investment Inflows

(In billions of U.S. dollars)

Source: IMF, WEO database.1Sharp decline in 2002 reflects contraction in flows into Hong Kong SAR.

There is evidence of investment diversion in selected countries and industries. For example, in Korea, overseas net investment increased by 42 percent annually during 2002–04; during this period, almost 43 percent of overseas investment was directed towards China. SMEs accounted for around 40 percent of overseas investment, double the share of the early 1990s. According to research by the Korea Development Institute, SMEs tend to reduce their domestic investment after making overseas investment, while large companies increase both together. With a rising share of overseas investment undertaken by SMEs, the increase in Korean firms’ overseas investment in China could thus have crowded out some domestic investment. In the electronics sector, investment in fabrication plants has risen sharply in China at the same time that it has fallen in Southeast Asia (Box 3).


Korea: Overseas Investment

(In billions of U.S. dollars)

Source: Export-Import Bank of Korea.

That said, recent formal studies have been unable to find systematic evidence that China is diverting FDI from other Asian countries.9 Indeed, after controlling for other drivers, some studies find that inflows of FDI to most Asian countries seem to be positively related to flows into China, suggesting complementarity, albeit to a varying degree among recipient countries. In other words, it appears that the growth both in China’s domestic market and in its exports has created demand for products from other countries, and thus new opportunities for trade and investment—including new opportunities for other countries to invest in order to be part of China’s expanding production chain, and these opportunities may have outweighed the diversion of investment in other industries. These results, it should be noted, do not necessarily refute claims that China is diverting investment from emerging Asia, as FDI is generally small relative to domestic investment; that said, FDI should be a barometer of investment more broadly, if foreign and domestic investment respond to the same incentives.

Investment Risk

So, if restructuring and diversion of investment to China do not seem to explain the low level of investment, what does? One possibility is an increase in risk. Modern microeconomic investment theories give uncertainty a central role, proving that greater uncertainty will lead agents to put off investing (Dixit and Pindyck (1994)). Greater risk could also have led agents to divert investment to lower-risk countries (a factor not captured in FDI regressions).

At first blush, however, the hypothesis of greater risk seems counterintuitive. After all, since the crisis exchange rate regimes have been made more flexible, banking and corporate sectors have been strengthened, and large stocks of foreign exchange reserves have been accumulated, all of which have made Asia less vulnerable to crisis. Yet, several measures show that perceived risks have increased, not declined. For example, the perceived ranking of the governance environment is weaker compared with the pre-crisis period. Along six different dimensions—voice and accountability, political stability, government effectiveness, regulatory quality, the rule of law, and control of corruption—emerging Asia ranked lower in 2004 than in 1996. What could have caused this deterioration in investment sentiment? The answer is unclear. Investor perceptions may, to some extent, be more realistic than they were prior to the Asian financial crisis. Investors were likely underestimating investment risks prior to the crisis, and moreover, with the withdrawal of government guarantees and explicit cross-guarantees, they appropriately bear more of those risks. But whatever the underlying reasons, the deterioration in perceptions is likely to have had a real impact: for example, governance is a significant determinant of FDI.10


Emerging Asia: Governance Indicator1

(Average, top ranking = 100)

Source: World Bank.1 Excludes China.

Moreover, the perceived increase in risk is not necessarily just an artifact of the crisis. It also reflects changes in the structure of trade and production, which are apt to persist in the future. This is because with the shift of lower value-added manufacturing activities in sectors such as textiles to China, other Asian countries have shifted production towards higher-end electronics markets, one of the most volatile sectors of the global economy.

Emerging Asia: Product Shares in Exports1

(In percent)

article image
Source: World Integrated Trade Solution Database.

Excludes China.

In fact, the volatility of output growth has been elevated since 1997, only very recently receding to slightly above pre-crisis levels. (G-7 output variability has also risen modestly, although it remains below 1980s peaks, reflecting the documented “great moderation” in volatility.11) This partly reflects the weakness of domestic demand. Traditionally, export booms have triggered investment surges, with the lag between the two allowing domestic demand to play a countercyclical role, surging just as export booms have begun to fade. But with the aforementioned breakdown in the relationship between exports and investment, domestic demand no longer plays this role, leaving countries more exposed to fluctuations in global demand. Consistent with this notion, the volatility of exports has broadly tracked that of output, rising sharply in the late 1990s and only recently declining to around mid-1990s levels. At the same time, exports seem to have become more procyclical, with exports growth closely tracking the growth of overall GDP in the region.


Emerging Asia: Growth Volatility1

(Standard deviation of real GDP growth)

Sources: IMF, WEO database; and staff estimates.1 Excludes China and India.2Rolling 12-quarter standard deviation.

Emerging Asia: Export Volatility1

(Standard deviation of real exports growth)

Sources: IMF, WEO database; and staff estimates.1 Excludes China and India.2Rolling 12-quarter standard deviation.

Emerging Asia: GDP and Exports Growth1

(Y/Y percent change)

Sources: IMF, WEO database; and staff estimates.1 Excludes China and India.

Unsurprisingly, the risks surrounding the outlook have consequently increased. Consensus surveys show a sizeable increase in the dispersion of forecasts, along with a sharp decline in expected GDP growth. Both the greater uncertainty and the lower expected growth could have pushed down investment in the post-crisis period.


Consensus Forecasts: GDP Growth

(Percent change)

Source: Consensus Economics. Simple averages for Indonesia, Korea, Malaysia, Singapore, Thailand. Forecasts are as of January for subsequent year. (e.g. “1996” = January 1995 forecast of 1996 growth).

To summarize, one factor that might have held back investment in Asia is macroeconomic and microeconomic uncertainty. Corporate and financial sector restructuring, which once acted as a constraint on investment, no longer seem to be an important factor at a regional level. Similarly, competition from China seems to have played a limited role, at least for the region as a whole. However, both the economic outlook, and the microeconomic environment as measured by governance indicators, have become riskier, and this may well be weighing on investment.

Outlook and Tentative Policy Implications

The medium-term outlook for investment varies considerably across sub-regions of emerging Asia. According to IMF staff forecasts, in the NIEs the investment ratio is projected to remain broadly flat. In the ASEAN-4, the investment ratio is projected to stage a modest recovery, but would remain well below the pre-crisis peak. In India, by contrast, the ratio is projected to rise to well above mid-1990s levels.


Emerging Asia: Investment Outlook1

(In percent of GDP)

Source: IMF, WEO database.1 Excludes China.

Many factors will shape the actual outturn for investment in the nearer and longer term. Over the near term, these include the strength of world demand and the pace at which global financial conditions tighten as the monetary policy cycle advances in the major countries. Movements in the IT cycle will also play an important role. Over a long-term horizon, demographics will have a growing effect, given the pending acceleration of population aging. In many Asian countries, the old-age dependency ratio is set to double or triple over the next five decades, potentially reducing both savings and investment.12


Emerging Asia: Population aged 65 and over1

(In percent of total population)

Source: United Nations.1 Excludes China and Taiwan POC.

It is worth reiterating that a return to inflated pre-crisis investment levels is neither likely nor warranted. As discussed above, the post-crisis decline in investment partly reflected a collapse in overheated real-estate markets, which in some countries (for example Singapore) reflected the bulk of the investment decline. In addition, technological innovation, by creating more efficient capital goods, could conceivably lower the optimal investment ratio, although these goods also tend to depreciate rapidly, and the effect seems likely to be small. More generally, the “right” level for investment is impossible to identify with any precision.

That said, the above analysis suggests a few general ways in which the environment for investment could be enhanced in selected countries:

  • Prudent monetary and fiscal policies have helped to contain any increase in perceived macroeconomic risk; sustaining such policies (and enhancing them where there is room for improvement) is warranted.

  • Structural improvements in the investment environment, notably in governance frameworks, would in some instances be helpful as well, to deal with uncertainty, raise expected rates of return, and improve competitiveness in the face of globalization. Key elements could include trade liberalization, deregulation, and improvements to infrastructure. (At the same time, subsidies and guarantees that distort investment decisions should be avoided.) Such steps would be in line with the G-20’s agreed strategy to enhance the investment climate.13

  • Deepening and broadening financial systems, especially by encouraging the further development of corporate bond markets, can both develop additional channels to finance investment and provide backstops for banking systems in the event of stress. At the same time, better-developed financial systems can help firms to cope with a more uncertain environment by facilitating the management and diversification of investment risks through financial markets.

Within this broad envelope, however, the emphasis of policy prescriptions would need to depend on the circumstances in individual countries. To give a few examples:

  • In the Philippines, the investment climate could be improved by ensuring fiscal sustainability and macro stability, enhancing the infrastructure and reforming the power sector, and strengthening and deepening financial markets.

  • In Malaysia, as recognized in the National Integrity Plan, steps are needed to improve investor perceptions, which remain worse than pre-crisis levels; a staff study has also found evidence of financing constraints for smaller firms and those in the service sector. Finally, investors also see a need to enhance the skills base.

  • In Indonesia, desirable reforms to improve the investment climate include strengthening governance at tax offices and customs, enhancing labor market flexibility, and addressing corruption.

  • In Korea, remaining weaknesses in small and medium-sized enterprises that have restrained facilities investment, as well as rigidities in labor markets, are key issues to be tackled.

  • In India, it would be useful to ease infrastructure and power bottlenecks, improve the business climate and regulatory environment (by streamlining bureaucratic procedures and further relaxing limits on FDI), continue with trade liberalization, and reform restrictive labor laws.

Finally, the increase in uncertainty suggests that savings could play an important role in the adjustment in current-account balances, after all. In particular, the riskier macroeconomic and microeconomic environment may have prompted firms and households to increase precautionary savings, in addition to dampening investment. If this is correct, steps to alleviate the perceived risks in the macroeconomic and microeconomic environments could both reduce savings and boost investment, helping to narrow current account imbalances along both dimensions.


  • Bernanke, B. S., 2004, “The Great Moderation,” Remarks at the meetings of the Eastern Economic Association, Washington DC, The Federal Reserve Board, http://www.federalreserve.gov/boarddocs/speeches/2004/20040220

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  • Brooks, R., 2003, “Population Aging and Global Capital Flows in a Parallel Universe,” Staff Papers, International Monetary Fund, Vol. 50, No. 2, pp. 200221.

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  • Chantasasawat, B., K.C. Fung, H. Iizaka, and A. Siu, 2004, “Foreign Direct Investment in China and East Asia,” Stanford Center for International Development Working Paper No. 233, Stanford University.

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  • Chinn, M.D., and H. Ito, 2005, “Current Account Balances, Financial Development and Institutions: Assaying the World ‘Savings Glut’,” NBER Working Paper 11761(November).

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  • Dixit, A.K., and Pindyck, R.S., 1994, “Investment under Uncertainty,” Princeton University Press, Princeton University

  • Eichengreen, B., 2006, “The Blind Men and the Elephant,” Issues in Economic Policy, The Brookings Institution.

  • Eichengreen, B., and Tong, H., 2005, “Is China’s FDI Coming at the Expense of Other Countries?” mimeo, University of California, Berkeley and Bank of England.

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  • International Monetary Fund, 2005, World Economic Outlook, September 2005: Global Imbalances: A Saving and Investment Perspective, World Economic and Financial Surveys (Washington), pp. 91124.

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  • International Monetary Fund, 2006, World Economic Outlook, April 2006, World Economic and Financial Surveys (Washington).

  • Kramer, C., G. Dell’Ariccia, A. D’Hoore, L. Eskesen, R. Guimaraes-Filho, K. Kang, O. Unteroberdoerster, and R. Siregar, 2006, “Analyzing Asia’s Investment Decline,” unpublished manuscript, (Washington: International Monetary Fund).

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In this chapter, “emerging Asia” comprises Hong Kong SAR, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan Province of China, and Thailand (that is, it excludes inter alia China).


Eichengreen (2006) surveys the debate surrounding the emergence of global imbalances.


These data are subject to a number of important limitations, including a lack of coverage of the pre-crisis period and comparability across countries (reflecting differences in accounting and regulatory practices). In addition, nonperforming loan figures are on a gross basis (NPLs net of provisioning are substantially lower in some cases). Finally, the financial and corporate sector figures may be subject to survivor bias—the improvements in financial health may be due in part to the liquidation of the worst-performing entities.


The 1998 spike may reflect sharp exchange rate depreciation that inflated the local currency value of foreign-currency loans.


Given the expansion of household lending in some countries, corporate borrowing may even have posted a modest decline.


Korea is examined alongside the ASEAN-4 in the figure because corporate-sector problems were important in Korea’s financial crisis.


Interest coverage is the ratio of earnings before interest and taxes to interest expenses.


Indeed, corporate savings have risen in G-7 countries in the recent period, in part for similar reasons (see World Economic Outlook April 2006).


Chantasasawat and others (2004), Mercereau (2005), and Eichengreen and Tong (2005). The first two papers examine total inflows (including from other Asian countries); the latter examines flows from Europe, North America, Australia, New Zealand, and South Korea.


Bernanke (2004) discusses the “great moderation.”


Effects on current accounts are consequently ambiguous in theory; however, Brooks (2003) estimates that on balance, both China and Japan will develop sizeable external deficits.


“G-20 Accord for Sustained Growth,” Berlin, November 21, 2004.