The Department

International Context

The East Asian economic crisis highlighted the complex international environment in which the portfolio operates. The crisis was the biggest external economic shock to Australia for many years, with potential to affect Australia’s economic, strategic and political interests. It underlined the importance of maintaining a foreign and trade service characterised by strength in analysis and policy advice, and the ability to respond quickly to change, whether in foreign and trade policy, advancing Australian business and economic interests, or providing assistance to the increasing numbers of Australians overseas. It also underlined the importance of innovative and flexible aid efforts in helping countries to deal with the social and economic effects of the crisis, and the importance of a dynamic, long- term approach to advancing Australia’s national interests internationally.

Although circumstances varied in individual economies, combinations of overheating, overvalued exchange rates, growing current account deficits, increasing debt burdens and long- standing financial sector weaknesses set the scene for the economic crisis. Following reduced export growth, the decline in Thailand’s stock market and weakened investor confidence, unsustainable pressures to sell the baht led Thailand to float its currency on 2 July. The ensuing currency crisis spread quickly as financial markets turned their scrutiny to Indonesia and the Republic of Korea, and developed into an economic crisis throughout East Asia early in 1998.

With the East Asian region home to seven of Australia’s top ten export markets and accounting for over half of Australian exports, the crisis shook expectations that Australian business opportunities in the region would continue to expand. Growth in Australian exports to East Asia, particularly of consumer goods, began to slow, although raw and intermediate goods were affected less dramatically. There were indications that Australian exporters, where possible, shifted from the markets most affected by the crisis to other destinations. Despite the regional difficulties, in 1997- 98, Australia’s merchandise exports increased by 11 per cent (recorded trade) over 1996- 97 figures. This included a five per cent increase in merchandise exports to East Asia and a 19 per cent increase in exports to non- East Asian markets.

Although the long- term impact of the East Asian economic crisis remains to be seen, globally the momentum of trade liberalisation was maintained. APEC leaders reinforced their commitment to continued trade and investment liberalisation, agreeing on a program of Early Voluntary Sectoral Liberalisation in fifteen key sectors; Australia played a leading role in these agreements. There was continuing progress in implementing the outcomes of the Uruguay Round of multilateral trade negotiations. The second WTO Ministerial Conference reaffirmed that mandated negotiations on agriculture and services would go ahead as scheduled, with a new broadly- based multilateral trade round likely by 2000. The conclusion of the WTO Financial Services negotiations brought Australia major market access gains in key financial markets.

Asia and the Pacific

In addition to the East Asian economic crisis, a second major challenge to the region came from India’s nuclear testing in May and subsequent testing by Pakistan. This increased the potential for serious conflict in the region and had global implications. The international community strongly condemned the tests, and Australia and other countries adopted concrete measures in response.

In the wake of the East Asian economic crisis, the region faced a multitude of challenges brought about by rising inflation, growing unemployment, and diminished purchasing power, together with reduced government spending capacity in health and education, all of which led to increased poverty. Agricultural production levels were significantly reduced by the effects of an extraordinarily strong El Niño weather pattern. ASEAN grappled with cross- border pollution problems from fires and smoke, and widespread drought. The deteriorating economic climate also raised questions about ASEAN’s ability to integrate new members Vietnam, Burma and Laos. Internal debate began on whether the organisation should change the way it operates to allow more frank dialogue between members to address such problems.

Individual countries in the region faced their own challenges. Political and economic uncertainty in Indonesia led to intensified pressure by student groups on the newly re- elected President Soeharto, which culminated in the events of 12 to 18 May in Jakarta and the President’s resignation on 21 May. President Habibie was appointed his successor and a vital period of transition to a new post- Soeharto order began. With new demands for change in East Timor, the Indonesian Government initiated dialogue with Bishop Belo and put forward a proposal for autonomy to be discussed with Portugal. In Thailand, a new government was appointed amid calls for more effective measures to deal with the economic crisis. Malaysia was affected too; its economy shrank for two consecutive quarters in 1998, marking its first recession in 13 years. Political tensions escalated in Cambodia, culminating in political violence that saw one of the country’s two Prime Ministers leave the country in July. He was able to return at the end of March to participate in the election campaign under an agreement brokered by Japan, ASEAN and the ‘Friends of Cambodia’ group, which includes Australia. Political stalemate between the military government of Burma and the democratic forces led by Aung San Suu Kyi continued throughout the year, with the situation increasingly tense at the end of the review period.

While also feeling the impact of the East Asian economic crisis, the United States underpinned its status as the world’s largest, most technologically advanced economy. Consumer and investor levels hit record highs as it registered its lowest unemployment rate for 24 years, lowest inflation rate for 30 years and highest home ownership rate in its history. Australian exports to the United States increased by 40 per cent over the previous review period. This made it Australia’s second biggest export market, overtaking the Republic of Korea. The United States continued to exercise leadership in the Asia Pacific region commensurate with its strategic and economic interests. Relations with China and Japan remained a key focus, while the United States also maintained its close interest in the Middle East and advanced its agenda with Russia, including in the context of broader trans- Atlantic security.

Japan’s economic difficulties increased, with Japanese policy makers facing specific domestic challenges, particularly in banking and financial sector reform. A fiscal stimulus package was announced on 24 April and its implementation later accelerated. Japan’s difficulties notwithstanding, Australia’s exports there grew 14 per cent over the previous review period, as Japan continued to be Australia’s largest trading partner and a significant source of direct investment.

A new, more dynamic leadership committed to a renewed push for economic reform was installed in China, and the world witnessed the handover of Hong Kong on 1 July. Protected by its limited integration with world financial markets, China remained relatively unscathed by the economic crisis, although weakening growth in exports and foreign investment contributed to declining economic growth in the second half of the review period. Exports to China grew by 8 per cent during the review period, representing a slight drop on the five- year growth trend of 11.8 per cent. Despite this, China remained Australia’s fifth largest trading partner. China took an active and constructive role in regional affairs, joining the international community in expressing deep concern at the nuclear tests conducted by India and Pakistan, and expressing its support for the international non- proliferation regime.

The election of opposition leader Kim Dae- Jung as President of the Republic of Korea was widely regarded as an affirmation of ROK democracy. Bolstered by a US$ 58 billion assistance package concluded in December with the IMF and supported by Australia, the new administration undertook a program of far- reaching economic reforms aimed at resuming strong economic growth. Continuing DPRK provocations did not prevent the administration from announcing a policy of greater political, economic and social engagement with the North.

Regional economic reform continued to be a focus for the countries of the South Pacific. The inaugural South Pacific Forum Economic Ministers Meeting hosted by Australia in July endorsed an Action Plan committing Forum Island Countries to enhanced public accountability, private sector development and more open trade and investment policies— an achievement overshadowed at the time by publication in the media of sensitive Australian government briefing documents. The fiftieth anniversary meeting of the South Pacific Conference also was important in progressing sustainable economic development.

Like others in the region, Papua New Guinea continued to grapple with economic difficulties exacerbated by its worst drought on record. The Government of new Prime Minister Skate worked towards an IMF- World Bank reform program to promote stability and structural adjustment. Australia, New Zealand and regional allies, which had all contributed to a substantial diplomatic effort to encourage a political solution to the Bougainville conflict, were buoyed by the signing of a ceasefire on 30 April. A multinational truce- monitoring mission established in November later became a peace monitoring force as PNG and international efforts began to focus on the reconstruction of Bougainville.

Major Developments outside the Asia Pacific Region

Trade and investment links with Europe strengthened, including a one- third increase in Australian exports to Europe and an expansion of European investment in a range of sectors in Australia. Significant steps were made towards greater European integration, and 11 EU member states are now set to participate in Economic and Monetary Union from 1 January 1999, with the European single currency, the euro, to come into existence as a unit of account at the same time. Formal negotiations for accession to the European Union began with Cyprus, Hungary, Poland, Estonia, the Czech Republic and Slovenia. In response to its Uruguay Round obligations and the prospect of enlargement, the European Union also began an internal debate on reform of its Common Agricultural Policy and other spending programs. The North Atlantic Treaty Organization decided to expand its membership to include Poland, the Czech Republic and Hungary.

A further positive development in Europe was the reaching of a comprehensive peace settlement on Northern Ireland in April, subsequently endorsed in May by referendums held in Northern Ireland and the Republic of Ireland. Obstacles to attaining complete peace still remain, but the international community has provided solid political and financial support, specifically through the International Fund for Ireland. Meanwhile, tensions continued in the western Balkans, with conflict between ethnic Albanians in the Yugoslav province of Kosovo and the government in Belgrade, despite international measures to encourage a political settlement to the conflict, including the imposition of an arms embargo against the Federal Republic of Yugoslavia by the UN Security Council.

Russia was integrated further into world affairs, with admission as a full member of the G7 (G8), APEC and the Paris Club, and the continuation of negotiations for its accession to the WTO. Its economic situation, however, remained precarious. President Yeltsin appointed a new government in April in an attempt to reinvigorate the economic reform process and it quickly embarked on a program of legislative action aimed at correcting the budget imbalance. However, the Government faced strong domestic opposition, with considerable uncertainty over the likely success of the reform efforts in the long term.

In Latin America, negotiations for a Free Trade Area of the Americas were formally launched in April at the Americas summit meeting in Santiago. The MERCOSUR countries (Argentina, Brazil, Paraguay and Uruguay) made clear they would negotiate in the FTAA as a bloc, in an effort to balance the dominance of the United States in the negotiations. MERCOSUR’s success as an economic integration mechanism was also reflected in the increasing interest European, North American and Australian investors showed in the MERCOSUR market. The continued commitment to strengthening democracy in the region heightened the attractiveness of Latin American countries, particularly Chile, as stable destinations for Australian investment.

In the Middle East, prospects for immediate movement in the peace process remain dim, despite the temporary resumption in November of talks between Israel and the Palestinians. The major sticking points between the two sides have been settlement activity, action against terrorism, troop redeployment and interim agreements on transport issues in Gaza. More positively, Australia’s trade with the Gulf states in particular grew rapidly during the review period.

Global Cooperation

The first step in the long- term task of addressing the global problem of climate change was made, with agreement on the Kyoto Protocol to the UN Framework Convention on Climate Change, providing for differentiated country commitments to greenhouse gas levels. The outcome met key Australian objectives, ensuring an acceptable, realistic and equitable emissions target. UN activity more broadly continued to be overshadowed by financial difficulties resulting from the failure of member states, most critically the United States, to pay their arrears. A major reform package introduced by Secretary- General Annan was adopted, and continuing contraction of UN peacekeeping activity helped ease the financial situation and reduced the level of UN contributions for all member states.

Iraq’s refusal to cooperate with UN weapons inspectors and renounce its capacity to produce weapons of mass destruction again brought it into confrontation with the international community. Supported by a strong stand by the international community, including the threat of force, the UN Secretary-General played a key role in ensuring a diplomatic solution to the crisis, finalising an agreement with the Government of Iraq on 23 February. Australia contributed troops and aircraft to a coalition force to ensure Iraq’s full compliance with relevant UN Security Council resolutions.

Important progress was achieved in the broader non- proliferation and disarmament agenda, with an historic Special Session of the Conference on Disarmament on 2 June demonstrating the strength of condemnation of India’s and Pakistan’s nuclear testing. The number of signatories to the Comprehensive Nuclear Test- ban Treaty reached 149 and the number of ratifications reached 14, with Australian ratification nearly completed. Implementation of the Chemical Weapons Convention proceeded well and a further 17 countries ratified the Convention. Conclusion of the Ottawa Convention, banning the use, transfer, production and stockpiling of anti- personnel landmines, was a major achievement.

Human rights continued to be a major focus of concern for global cooperation, with growing recognition of the inseparability of economic, social and cultural rights from civil and political rights. Greater emphasis was given to practical measures to promote and protect human rights, including through national human rights institutions, and significant progress was made towards establishing an International Criminal Court.

International Aid Flows

Aid and other financial flows to developing and transitional countries fell substantially in 1997. Official Development Assistance to developing countries declined, with preliminary reporting for 1997 by members of the OECD’s Development Assistance Committee showing that, as a percentage of their combined gross national product, ODA fell to 0.22 per cent in 1997, the lowest level ever recorded.

The Australian Government provided $1.5 billion as ODA in the review period, $30 million more than anticipated in the budget due to additional funding for drought relief in Papua New Guinea ($ 17.8 million), and humanitarian assistance for Indonesia ($ 7 million). This put Australia’s aid as a percentage of GNP at 0.28 per cent, well above the international donor average of 0.22 per cent.

Figure 1: Australian 1997-98 Aid Program

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