Speech

98/2

Remarks by Michel Camdessus
Managing Director of the International Monetary Fund
at the Council on Foreign Relations

New York, February 6, 1998

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Ladies and gentlemen, it is a pleasure to join you here once again at the Council on Foreign Relations and to have this opportunity to talk to you about what the Fund is doing in Asia.

So much has already been said and written about the Asian crisis, that I don't need to recount past history. Nor do I plan to describe the details of the Fund-supported programs in Thailand, Indonesia, and Korea, since anyone who is interested can check the websites of the IMF and these countries, where they can read the full text of the commitments that these countries have made to the IMF in their "letters of intent."

Instead, I would like to explain briefly what these programs are trying to achieve. Then, since there are still quite a few misconceptions about what the Fund is doing in Asia, I would like to set the record straight on a few points. Finally, I will say a few words about the implications of the Asian crisis for the future architecture of the international financial system.

A new approach

So what are these programs in Thailand, Indonesia, and Korea all about? Many people assume that they must be the same kind of belt tightening adjustment programs that the public has long associated with the Fund. Quite the contrary. These programs represent a marked departure from the kind of programs we have traditionally supported in the past.

I say this because the centerpiece of each program is not a set of austerity measures to restore macroeconomic balance, but a set of forceful, far-reaching structural reforms to strengthen financial systems, increase transparency, open markets and, in so doing, restore market confidence. To this end, non-viable financial institutions are being closed down, and other institutions are being required to come up with restructuring plans and to comply--within a reasonable period that varies from countries to country--with internationally accepted best practices, including Basle capital adequacy standards and internationally accepted accounting practices and disclosure rules. Other institutional changes are under way to strengthen financial sector regulation and supervision, increase transparency in the corporate and government sectors, create a more level playing field for private sector activity, and increase competition. Taken together, these reforms will require a vast change in domestic business practices, corporate culture, and government behavior, which will take time. But the process is already in motion, and already some dramatic steps have been taken.

Will it work?

A dramatic departure, yes. But will it work? Some have argued that these programs are still too tough, either in calling for higher interest rates, tightening government budget positions, or closing down financial institutions. Let's take the question of interest rates first. By the time these countries approached the IMF, the value of their currencies was plummeting, and in the case of Thailand and Korea, reserves were perilously low. Thus, the first order of business was, and still is, to restore confidence in the currency.

Here, I would like to dispel the notion that the deep currency depreciations seen in Asia in recent months have occurred by IMF design. On the contrary, in our view these currencies have depreciated far more than is warranted or desirable. Moreover, without IMF support as part of an international effort to stabilize these economies, it is likely that these currencies would have lost still more of their value.

To reverse this process, countries have to make it more attractive to hold domestic currency, and that means temporarily raising interest rates, even if this complicates the situation of weak banks and corporations. This is a key lesson of the "tequila crisis" in Latin America 1994-95, as well as from the more recent experience of Brazil, Hong Kong, and the Czech Republic, all of which have fended off attacks on their currencies over the past few months with a timely and forceful tightening of interest rates, along with other supporting policy measures. Once confidence is restored, interest rates can return to more normal levels.

Let me add that companies with substantial foreign currency debts are likely to suffer far more from a long, steep slide in the value of their domestic currency than from a temporary rise in domestic interest rates. Moreover, when interest rate action is delayed, confidence continues to erode. Thus, the increase in interest rates needed to stabilize the situation is likely to be far larger than if decisive action had been taken at the outset. Indeed, the reluctance to tighten interest rates in a determined way at the beginning has been one of the factors perpetuating the crisis. Higher interest rates should also encourage the corporate sector to restructure its financing away from debt and toward equity, which will be most welcome in some countries, such as Korea.

Other observers have advocated more expansionary fiscal programs to offset the inevitable slowdown in economic growth. Here, the programs must strike a delicate balance. At the outset of a crisis, countries need to firm their fiscal positions, to deal both with the future costs of financial restructuring and--depending on the balance of payments situation--with the need to reduce the current account deficit. Beyond that, if the country's economic situation worsens, the IMF generally agrees to let automatic stabilizers work and allow the deficit to widen somewhat. However, we cannot disregard the level of the fiscal deficit, particularly since a country in crisis typically has only limited access to borrowing and the alternative of money printing would be potentially disastrous.

Likewise, we have been urged not to recommend rapid action on banks. It would be a mistake, however, to allow clearly bankrupt banks to remain open, as this would only perpetuate the region's financial crisis, not resolve it. The best course is to recapitalize or close insolvent banks, protect small depositors, and require shareholders to take their losses. At the same time, banking regulation and supervision must be improved. Of course, we take individual country circumstances into account in deciding how quickly all of this can be accomplished.

In short, the best approach is to effect a sharp, but temporary, increase in interest rates to stem the outflow of capital, while making a decisive start on the longer-term tasks of restructuring the financial sector, bringing financial sector regulation and supervision up to international standards, and increasing domestic competition and transparency. None of this will be easy and, unfortunately, the pace of economic activity in these economies will inevitably slow. But the slowdown is mainly the result of the reversal of capital flows. Without these programs and the international support behind them, the slowdown would be much more dramatic, the costs to the general population much higher, and the risks to the international economy much greater.

Of course, not everyone agrees with this approach. Some say that it would be better simply to let the chips fall where they may, on the grounds that providing assistance to countries in crisis will only encourage more reckless behavior on the part of borrowers and lenders in the future. I do not share this view. First of all, the notion that the availability of IMF programs encourage countries to behave recklessly is not very plausible: no country would deliberately court such a crisis even if it thought international assistance would be forthcoming. The economic, financial, social, and political pain is simply too great. Nor do countries show any great desire to enter IMF programs unless they absolutely have to.

Second, despite the constant talk of bailouts, most investors are taking heavy losses in the crisis. With stock markets and exchange rates plunging, foreign equity investors have lost nearly three quarters of the value of their equity holdings in some Asian markets. Many firms and financial institutions in these countries will go bankrupt, and their foreign and domestic lenders will share in the losses. International banks are also sharing in the cost of the crisis. Moreover, the fourth quarter earnings reports now becoming available indicate that, overall, the Asian crisis has been costly for foreign commercial banks. It is true that some short-term creditors are being protected, and this is an issue that needs to be addressed. But in the case of Korea, they are being bailed in at longer maturities and below comparable market rates.

The bottom line is that there is a trade-off in how the international community chooses to handle the Asian crisis. It could step back, allow the crisis to deepen, bring additional suffering to the people of the region and, in the process, possibly teach a handful of international lenders a better lesson. Or it can step in and try to do what it can to mitigate the effects of the crisis on the region and the world economy, albeit with some undesired side effects. In my view, the global interest lies in containing and overcoming this crisis as quickly as possible. And working through the IMF offers the most expeditious and cost-effective way of doing this.

Toward a new architecture

Let me turn now to some of the ways in which the Asian crisis may affect the international monetary system. In the initial months of Asia's financial turmoil, much of the world's attention was focused on how to contain the crisis. But today thoughts are turning to how best to strengthen the international financial system so that such crises will be less likely to occur in the future and those that do occur can be handled more effectively. Although seven is a pleasing number, I see six pillars supporting this new architecture. Why only six? Well, perhaps because this new edifice is still on the drawing board. Briefly, these pillars are:

• one, more effective surveillance over countries' economic policies, facilitated by fuller disclosure of all relevant economic and financial data. As you may know, the IMF has established data standards to guide members in releasing reliable data to the public. It is also promoting fuller disclosure through its programs and policy advice.
• two, regional surveillance, because experience shows that there is considerable scope for improving economic performance on a regional basis when neighboring countries get together to encourage one another--or put pressure on one another--to pursue sound policies. The Fund is assisting with such initiatives in Asia, just as it already does in the G-7 and other fora.
• three, financial sector reform, including better prudential regulation and supervision. Working with the World Bank and others, the Fund has helped develop and disseminate a set of "best practices" in the banking area, so that standards and practices that have worked well in some countries can be adopted and applied in others.
• four, more effective structures for orderly debt workouts, including better bankruptcy laws at the national level and, as recommended by last year's study by the G-10, better ways at the international level of associating the private sector with official efforts to help resolve sovereign debt problems.
• five, orderly capital account liberalization: this means neither a return to antiquated capital controls nor a mad rush to full immediate liberalization, regardless of the risks, but properly sequenced and cautious liberalization, so that a larger number of countries can benefit from access to the international capital markets; and
• six, a strengthening of the international financial institutions, including their financial resources. At the IMF, we are deeply aware that support for the institution ultimately derives from members' legislatures, which vote on their countries' quotas, or subscriptions in the Fund. We know that we must work hard to merit their support. At the same time, however, we trust that the wisdom of legislators everywhere will lead them to see how much the IMF does to support economic well-being in their countries and around the world.

Suffice it to say, when all these elements are in place, the architecture of the international financial system will indeed be more modern and more substantial, and more equal to the challenges in the global economy today.

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Ladies and gentlemen, there are many more issues that I would like to discuss with you, but I do want to save some time for your comments and questions. So let me stop here and turn the floor over to you.