Asian flu may further infect world markets

Far East markets may have calmed down, but it would be a mistake to believe that the Asian crisis has passed. For some months it had appeared that the problems would be confined to the smaller Asian economies such as Indonesia and Thailand. But the crisis in South Korea and the collapse of Yamaichi signalled much deeper problems.

South Korea is a big economy - as big as Indonesia, Thailand and Malaysia together - and the turmoil in that economy has implications for Japan. For example, the collapse of the won will make it more difficult for Japanese exporters who must compete with Koreans on many world markets.

And the collapse of Yamaichi itself highlights the serious problems in the Japanese financial system. Slow growth and bad debts are putting pressure on the Japanese banks, and their exposure to the other troubled Asian economies will not help either.

Figures this week highlighted the extent of Japan's economic woes, showing that the economy shrank in the first half of this fiscal year and confirming that it is on the verge of falling into a recession.

A major onus now lies on the Japanese government. The priority must be to address the worries in the financial system and ensure that it does not hit a liquidity crisis. Such a development could lead to Japanese companies offloading some of their holdings of US Treasury bonds, with potentially disastrous consequences for world financial markets. And if economic growth does not pick up, the Government may be forced to rethink its promise to reform the public finances. Instead, it may be forced to increase public spending and reduce taxes in a bid to bolster the economy.

Against this background, the potential for more "shocks" to international financial markets from the Far East remains high.