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The Asian Crisis: Origins and Lessons

Address by Alassane D. Ouattara
Deputy Managing Director of the International Monetary Fund
at the Royal Academy of Morocco Seminar on
"Why Have the Asian Dragons Caught Fire?"

Fez, May 4, 1998

It is an honor for me to join you today, as you reflect upon the Asian financial crisis, its origins and lessons. Of course, your deliberations are most timely. Just a few weeks ago, the IMF’s Interim Committee, which is our governing body, debated the very same issues. The quest was to find a way forward so that we could better prevent crises and deal more effectively with those that still inevitably occur. And I would like to share with you the outcome of those deliberations—essentially an agenda to strengthen the architecture of the international financial system. But first, let us step back and trace what happened in East Asia.

Origins of the crisis

For the past three decades, no other group of countries in the world has produced more rapid economic growth or such a dramatic reduction in poverty. Korea, Malaysia, and Thailand have virtually eliminated absolute poverty, and Indonesia is within reach of that goal. Per capita income levels have increased tenfold in Korea, fivefold in Thailand, and fourfold in Malaysia. In fact, per capita income levels in Hong Kong and Singapore now exceed those in some Western industrial countries. And until the current crisis, Asia attracted almost half of total private capital inflows to developing countries—over $100 billion in 1996.

So how could events in Asia unfold as they did, given so many years of outstanding economic performance? In the case of Thailand, the answer is clear. To begin with, standard economic indicators revealed large macroeconomic imbalances: export growth had slowed markedly; the current account deficit was persistently large and financed increasingly by short-term inflows; and the real exchange rate had appreciated to a level that appeared unsustainable. These problems, in turn, exposed other weaknesses in the economy, including substantial, unhedged foreign borrowing by the private sector, an inflated property market, and a weak and over-exposed financial system. These weaknesses reflected undisciplined foreign lending, unfavorable movements in the yen-dollar rate, and weak domestic policies.

At the same time, developments in Thailand prompted market participants, especially those who had initially underestimated the problems in Thailand, to take a much closer look at the risks in neighboring countries. And what they saw—to different degrees in different economies—were many of the same problems affecting the Thai economy, including overvalued real estate markets, weak and poorly supervised banking sectors, and substantial private short-term borrowing in foreign currency. Moreover, after Thailand, markets—including domestic residents—began to look more critically at weaknesses they had previously considered minor, or at least manageable, given time. In other words, markets became less forgiving. They also panicked.

Market doubts were compounded by a lack of transparency—about the extent of government and central bank liabilities; about the underlying health of the financial sector; about the extent and structure of indebtedness in the private sector; and about the links between banks, industry, and government and their possible impact on economy policy. In the absence of adequate information, markets tended to fear the worst and to doubt the capacity of governments to take timely corrective action. The imposition of controls on market activity, and the possibility of future controls, not only made investments riskier but also tended to reinforce the view that governments were addressing the symptoms, rather than the causes, of their problems. This not only sent foreign investors fleeing to safer havens. It propelled a rush by domestic corporations, including those that had borrowed heavily in foreign currencies, to buy foreign exchange.

Implications for the World Economy

Against this backdrop, a spillover—or domino effect in the region—was inevitable, with implications for other emerging market economies and the world as a whole. The latest IMF estimates show that overall the world should see a slowdown in growth this year—to slightly over 3 percent, or about 1 percentage point lower than we had forecast before the Asian crisis hit. Even so, this slowdown is likely to be much less pronounced than those of 1974-75, 1980-83, and 1990-91.

In general, most major industrial countries, with Japan being the most significant exception, are well positioned to absorb the contractionary effects of the crisis. In Japan, recovery had stalled again before the Asian crisis, and the crisis will be exerting its effects at a most unwelcome time. But in the United States, the United Kingdom, and some other industrial countries, the Asian slowdown will help to fend off inflationary pressures. Consumer spending and investment in the United States remain strong and the data continue to show robust growth of output and employment; consumer confidence is at 30-year highs, and unemployment is at its lowest rate for a quarter century.

For developing countries, economic growth overall is expected this year to fall below the 6 percent average of the 1990s to around 4 percent, making it the slowest expansion for these countries since 1991. Those hardest hit, of course, will be in Asia—especially Indonesia, Korea, Malaysia, the Philippines, and Thailand. Most other emerging market countries may be expected to register a slowdown in growth followed by a mild strengthening next year.

As for Africa, growth in many African countries is expected to be in the neighborhood of 5 percent and continue at about this level over the medium term. This assumes strong structural adjustment policies, including efforts to strengthen governance, and continued support from the international community. However, the recent sharp declines in oil and other commodity prices pose considerable challenges for a number of developing countries and could temporarily affect growth and investment—even slowing progress in poverty reduction—especially in some African countries.

How are the crisis countries in particular faring? It is encouraging to note that for both Thailand and Korea—countries that have embarked on ambitious programs that go to the heart of their economic problems—market confidence seems to be returning. The Thai baht has strengthened by over 40 percent since its low in January, and the Korean won by over 30 percent since its low in late December. The Thai and Korean stock markets are up 13 percent and 8 percent, respectively, since the beginning of the year. And in both countries, new foreign direct investment and portfolio investment are beginning to flow back in again.

This is not to say that the situations in Thailand and Korea are easy. They are not. We expect GDP to decline by about 3 percent in Thailand this year and by 1 percent in Korea. This is very painful for countries accustomed to long-term growth rates of 7-8 percent and with so many social problems still to be resolved. But without these programs and the international support behind them, the slowdown in these economies would be much more dramatic, the costs for the general population much higher, and the risks to the international economy much greater. That being said, the IMF and the Thai and Korean authorities have been keeping developments under continuous review. And together, we have adapted the programs to cushion the downturn and its impact on the poor and the unemployed, while still ensuring that the tough adjustment that are needed are carried through.

In Indonesia, however, valuable time has been lost—due to policy slippages, including in the crucial area of monetary policy, as well as in some structural areas. As a result, the rupiah is now substantially over-depreciated, inflation has picked up dangerously, and economic conditions have deteriorated. This is why the Indonesian authorities and the Fund have recently agreed on a strengthened economic program, which includes a long list of prior actions—that is, measures that the Indonesian authorities are committed to take before the next tranche of the loan for Indonesia can be disbursed. Most of these actions have already been taken, but it is crucial that the authorities remain firmly committed to the program and implement it fully.

Lessons learned

So what are the lessons of the events of the past few months? Certainly, the globalization of the world’s financial markets offers unprecedented opportunities: the chance to quicken the pace of investment, job creation, and growth. Yet at the same time, it carries with it risks: a greater vulnerability to shifts in market sentiment, which can trigger massive shifts in capital, and in turn, precipitate banking sector crises with spillover effects in other economies. Clearly, recent developments in Asia show that these risks are significant. But it would be a mistake to conclude that they are insurmountable or to allow them to obscure the benefits of globalization.

Rather, what is needed are reforms that embrace a number of elements that are vital for economic growth and financial stability:

  • greater transparency and accountability in government and corporate affairs;

  • stronger banking systems that protect the savings of small depositors—and that must be freed from government intervention in the allocation of credit so that they can channel it not just to a favored few, but to those who will use it productively;

  • the liberalization of capital flows in a prudent and properly sequenced way that will maximize the benefits and minimize the risks of free capital movements;

  • a more level playing field for the private sector—by dismantling monopolies and setting up simpler, more transparent regulatory systems;

  • reductions in unproductive government spending, such as military build-ups, prestige projects, and subsidies and guarantees to favored sectors and firms; and

  • higher and more cost-effective spending on primary health care and education; adequate social protection of the poor, the unemployed, and other vulnerable groups; and environmental protection; and

  • a more effective dialogue with labor and the rest of civil society—to increase political support for adjustment and reform and to ensure that all segments of society benefit from the resumption of growth, while core labor rights are protected.

Looking Ahead

How can these lessons be used to help prevent financial crises and resolve those that still inevitably occur? The IMF’s Interim Committee is calling for action in four critical areas:

First, strengthen international and domestic financial systems. Over the past year or so, the IMF and World Bank have been working together to help disseminate a set of best practices in the banking areas—as developed by the Basle Committee on Banking Supervision—so that standards and practices that have worked well in some countries can be adapted and applied in others. The standards are codified in the Committee’s 25 core principles. These efforts must now be stepped up and broadened to cover other important areas, such as accounting, auditing, disclosure, asset valuation, bankruptcy, and corporate governance. And mechanisms need to be developed—in collaboration with the Bank for International Settlements and other international agencies—to monitor the implementation of the standards.

Second, strengthen Fund surveillance. The IMF must be more ambitious and demanding about the data provided to it and communicated to the markets. It needs to know more about the structure of countries’ external debt, their reserve levels, how highly leveraged their corporate sector is, and the level of nonperforming loans. The Fund must intensify its surveillance over financial sector and capital account issues, give greater attention to policy interdependence and risks of contagion, and monitor more closely market views and perspectives.

Third, improve the availability and transparency of information. In recent years, the IMF has taken numerous steps to enhance transparency and openness, including the establishment of standards to guide countries in publishing a regular and timely flow of comprehensive economic and financial data. The Fund will now expedite its efforts to broaden and strengthen the Special Data Dissemination Standard to cover additional financial data—such as reserve-related liabilities; central bank derivative transactions and positions; debt, particularly, short-term debt; and prudential banking indicators. The Fund will also continue to encourage countries to release the conclusion of the Article IV consultations by the Executive Board in the form of Press Information Notices. And ways need to be found to assure that markets and institutions utilize all the information available—building it into risk assessment and assuring that credit policy is based on such fully informed risk assessment.

Fourth, establish more effective procedures to involve the private sector in resolving debt crises. Clearly, better ways must be found to involve private creditors at an early stage, in order to achieve equitable burden sharing vis-a-vis the official sector and to limit moral hazard. This is a difficult task, but one we must now tackle.

As you can see we have a very ambitious agenda for the year ahead, one that no doubt will be characterized by the setting and disseminating of new standards and best practices—part of what we call the strengthening of the architecture of the international financial system. In pursuing this agenda, we will need to deepen our collaborative relationship with the World Bank and other international agencies. And we will be counting on a continuing dialogue with the international community and interested domestic parties to help inform this work.


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