Governor’s Adress by Dr C.L. Stals, Governor of the South African Reserve Bank, at the seventy-eighth Ordinary General Meeting of Shareholders of the Bank IntroductionDuring the past twelve months, global economic developments were dominated by the continued depressed conditions in Japan and the emergence of major financial crises in a number of East Asian countries. At the same time, the process of worldwide integration of financial markets progressed further. Irrevocable steps were also taken to introduce the Euro as a common currency for the members of the European Union.The South African economy, which is rapidly being integrated into the evolving interdependent worldwide system of markets, could not escape all of the adverse consequences of the developments in East Asia. For a smaller economy such as South Africa, the choice is straightforward – either to share in the major benefits, but then also in the periodic adversities, of the global financial integration process, or to insulate the economy from the rest of the world, and be dependent on the limited resources and opportunities available in the country for its own economic development. In view of an extremely low level of domestic saving, South Africa has no option other than to participate actively in the process of financial globalisation. Only as a participant in the global market will it be possible for the country to share in the surplus savings of the more mature economies of the world. There is an ongoing debate on the reasons for the sudden collapse of what were previously regarded to be highly successful and exemplary performances of the East Asian economies. With the benefit of hindsight, many reasons are now tendered for the development of cyclical and structural macroeconomic weaknesses that were partly disguised by years of sustained high economic growth. Central bankers are particularly interested in the widely supported view that at least three deficiencies in overall financial management can be recognised as important contributing factors to the economic crisis currently being experienced by a number of East Asian countries: The first is that relaxed monetary policies were applied over a protracted period of time to keep interest rates artificially low. These policies encouraged excessive increases in bank credit extension and in money supply growth that contributed to the undue inflation of financial asset and property prices. In the end, relative to their capital and reserves, banks found themselves overextended by loans and investments, partly based on the collateral of overvalued assets. Many private sector borrowers became heavily indebted and could not service a large part of their loans when interest rates increased. The situation was aggravated when the banking sector had to rely inordinately on short-term foreign loans for funding purposes.Secondly, lax financial regulation and supervision allowed a gradual deterioration in the quality of the assets of financial institutions. Banks in particular did not provide adequately for a growing burden of non-performing loans and low-yielding assets.Thirdly, a rigid exchange rate policy created a false sense of confidence and security. Large uncovered foreign currency positions increasingly exposed borrowers of offshore funds to exchange rate changes in an environment of rising international financial volatility.In the end when the bubble burst, inflated asset prices in both the financial and property markets tumbled. Non-resident investors rushed to withdraw funds from the East Asian economies. Sweeping exchange rate adjustments very quickly converted uncovered foreign currency positions into liquidity and credit problems. Subsequent drastic financial adjustments contributed to the collapse in the financial systems of some of these countries.There are many lessons to be learnt from the recent experience of the East Asian countries. Macroeconomic financial profligacy invariably leads to the demolition of economic and financial systems, albeit in some cases only after long time delays. Ultimately,