Speech

98/10 Address by Michel Camdessus
Managing Director of the International Monetary Fund
at the "Australia Unlimited" Round Table

Melbourne, Australia, May 5, 1998

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It is a great pleasure to participate in this "Australia Unlimited" round table. Australia, with its vast territory and natural resources, has long captured the world’s imagination as a land of almost unlimited possibilities. But today, a country’s prospects depend not just on its domestic resources but, increasingly, on what it makes of the opportunities and challenges in the global economy. The crisis in Asia speaks volumes on this subject. And so I would like to offer my perspective on developments in the region, some key lessons to be drawn from the crisis, and the implications for Australia and the rest of the international community. But before doing that, let me welcome the launching today of The Global Foundation, an initiative that I am sure will contribute greatly to the international orientation of Australia, and to realizing your country’s enormous potential through civic partnerships and a truly global perspective in the Centenary of the Federation. This is indeed a timely effort for all the reasons I will discuss today, and I congratulate all who have shared this vision and helped bring it to fruition.

Globalization and Asia

Let me begin with a few words about globalization. To a great extent, globalization is simply the continuation of the trend toward greater international economic integration that has been under way for the last fifty years. Today, however, markets are larger, more complex, and more closely integrated than ever before, and capital moves at speeds and in volumes that would have been inconceivable just a few decades ago.

Asia, in particular, has been the showcase of the benefits of globalization. In 1996, private capital flows to developing and transition economies reached an all time high of $235 billion; nearly half went to Asia. Clearly, some of those flows were not being invested wisely. But the fact remains: over the last several decades, the forces of globalization have allowed many countries in Asia to accelerate investment and growth, create more jobs, reduce poverty, and attain other important human development goals. In Indonesia, for example, the share of the population living below the poverty line declined from 60 percent in 1970 to 10 percent last year. In Korea, the literacy rate increased from around 30 percent in the mid–1950s to over 95 percent today. Globalization has helped make such human progress possible.

For advanced economies, including Australia, globalization has created buoyant export markets and many new jobs. Global financial markets have allowed investors to earn higher returns on saving and diversify their portfolios. They have also permitted a more efficient allocation of global resources and, hence, faster world growth. Moreover, the emergence of new economic powerhouses has, at times, provided a cushion against global recession. This was the case in 1991–93, when the dynamism of a number of emerging market economies helped sustain global economic activity despite successive downturns in industrial economies, including in Australia.

The fact that a crisis has struck does not diminish these past achievements or the future benefits that globalization can bring. But it is reason to reflect carefully on the risks in the global economy and on how, individually and collectively, countries can make the most of the global economic environment.

The crisis in Asia

Let me begin with some observations on what went wrong in Thailand, Korea, and Indonesia. Obviously, there were many factors at work, and it will be some time before we fully understand the crisis. But certainly, one major element was the fact that domestic institutions were not strong enough, and domestic policies were not flexible enough, to meet the increasing demands of economic success. These institutional and policy shortcomings manifested themselves in various ways, including:

• in the failure to address the overheating pressures seen in countries’ excessive credit expansion, inflated real estate prices, and widening current account deficits;

• in the lack of sufficient exchange rate flexibility, which undermined competitiveness and, along with implicit guarantees of support to banks and corporations, led to excessive external borrowing and foreign exchange exposure, often at short maturities;

• in lax prudential rules, inadequate supervision, and lending based on personal connections and government directive, which led to inefficient investment and a deterioration in the quality of bank balance sheets; and

• in the lack of data and transparency, which masked the extent of these countries’ vulnerabilities to the world community, but also to the countries themselves—to their own eyes—all of which contributed to policy inaction, lulled markets into a false sense of security, and later added to their panic.

As the crisis unfolded last fall, initial doubts about the authorities’ commitment to take the necessary steps—such as tightening monetary conditions and closing insolvent financial institutions—put additional pressure on currencies and stock markets. But investors and lenders also contributed to the eventual crisis; all of the problems I just cited were intensified by large capital inflows in search of high returns, in some cases without due regard for the potential risks.

IMF–supported programs

The economic adjustment and structural reform programs adopted in Thailand, Korea, and Indonesia seek to address these problems and thereby restore investor confidence, reestablish access to international capital markets, and reverse excessive currency depreciation. But the programs have also sparked considerable controversy.

Let me put aside the criticism of those who believe we can find instant miracle cures. They will always be disappointed!

Then come the surprise and reservations of those who miss the traditional IMF approach in what we are doing in Asia. Indeed, these programs are not the standard fare that many people expect from the IMF. Their main emphasis is not on reducing fiscal deficits, but on strengthening financial systems, improving governance and transparency, and enhancing domestic competition. This involves closing insolvent financial institutions and writing down shareholders’ capital; recapitalizing undercapitalized financial institutions; putting weak ones under close supervision; and increasing foreign participation in domestic financial systems. It also means publishing on a timely basis key economic and financial data, such as countries’ net foreign reserve positions; enhancing shareholder rights and breaking the close links between business, banks, and governments; and opening up domestic markets that until now have been controlled by monopolies to both domestic and foreign competition.

Is this too much intrusion into countries’ domestic affairs? On the contrary, it would be pointless, indeed reckless, and contrary to the IMF’s charter, for the IMF to use its members’ resources to support these programs unless there were strong reasons to believe that they would be successful in restoring market confidence and economic growth. And, of course, the programs can only do that if they get to the bottom of the problems that led to the crisis in the first place. That being said, the IMF can only meet a small part of these countries’ total resource needs; the overwhelming share must come from the private sector. The need to restore market confidence is all the more reason why the programs must tackle these difficult issues head-on.

Here in Australia, there has also been concern about the impact of these programs on domestic economies of countries that are, in some cases, your close neighbors and major trading partners. We have great respect for these concerns, and we share them.

Certainly, these are not easy times for countries accustomed to growing at 7–8 percent a year and with many pressing social needs still to address. But 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 priority was, and still is, to restore confidence in their currencies. To do this, countries have to make it more attractive to hold their currencies, and that means raising interest rates temporarily, even if this complicates the situation of weak banks and corporations and contributes to the slowdown in growth in the immediate period ahead. As confidence is restored, interest rates can return to more normal levels; indeed, interest rates have already begun to decline in Thailand and Korea, thanks to their forceful program implementation. Conversely, when the authorities fail to demonstrate their unequivocal commitment to a tight monetary policy, confidence continues to erode, the exchange rate continues to decline, and inflationary pressures begin to build up. Thus, the eventual increase in interest rates needed to stabilize the situation is likely to be far larger, and the accompanying economic contraction much greater, than if decisive action had been taken at the outset. Unfortunately, this has been the case in Indonesia.

On fiscal policy, the programs seek to strike a balance between the need to contain the deterioration in the fiscal positions and the need to accommodate the cost of financial sector restructuring and protect social spending. Here, the IMF’s approach has been flexible and pragmatic. The programs have been kept under constant review, and each has been adjusted to take account of changing circumstances. In Indonesia, the newly revised program includes temporary subsidies to protect low-income groups from the rise in prices of food and other essentials. It also makes provision for higher spending on health and education, including programs to finance essential drugs for rural and urban health centers and scholarships for needy students. Subsidized credit for small- and medium-size enterprises, labor-intensive public works, and temporary employment programs—mainly financed by the World Bank, the Asian Development Bank, and bilateral foreign assistance—will also help strengthen the social safety net.

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So, where are we now? I am happy to say that market confidence seems to be returning in both Thailand and Korea. The Thai baht and the Korean won have both strengthened by over 40 percent since their respective lows in January and mid–December. Likewise, the Thai and Korean stock markets are up 15 percent and 10 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. So even though both countries still have large reform agendas, especially in the banking sector, their financial crises are gradually receding. Of course, much of the pain of adjustment still lies ahead, as companies and workers adapt to the new environment, but, with perseverance, they should emerge stronger than before.

Turning to Indonesia, I would have to say that we are not yet at that point. A lot of time has been lost—due to policy slippages, including in the crucial area of monetary policy, and other developments. In the meantime, the rupiah has remained substantially over-depreciated, inflation has picked up sharply, and economic conditions have deteriorated. As a result, the program originally worked out with the IMF last November has had to be renegotiated and strengthened on two occasions.

Indonesia now has a revised and strengthened program in place—our third attempt to help the Indonesian authorities put their economy back on a sound footing. Understandably, market participants are waiting to see if, this time, there will be concrete evidence of policy reform. But there are some good reasons to expect that the program will be carried out. To begin with, the Indonesian officials with whom IMF staff have been working have made a serious effort to address the country’s fundamental problems, while seeking ways to mitigate the increased social costs of adjustment. Together, we have designed a strong program. It required many policy measures to be taken as prerequisites for the resumption of IMF financing; it also includes mechanisms for monitoring its implementation very closely. The fact that bank creditors have endorsed a broad framework for addressing Indonesia’s corporate debt problems is also very promising. Finally, the cost of past inaction for the Indonesian economy and the Indonesian people has become painfully clear to all—there is simply no more time to lose.

Lessons of the crisis

The crisis in Asia has prompted a great deal of reflection about what more could be done to prevent major financial crises and how to deal more effectively with those that, despite these efforts, will still arise.

Certainly, the single most effective step countries can take is to pursue sound and sustainable economic and financial policies. And given the ease with which contagion can spread, even countries with ostensibly strong fundamentals may, at times, need to tighten their monetary and fiscal policies to guard against spillover effects.

At the same time, since such crises are often provoked by problems in the financial sector, or intensified by them, much more needs to be done to strengthen domestic financial systems and the policies and institutions needed to underpin them. In particular, domestic financial systems must be strong enough to allow governments to tighten monetary policy as needed, without fear of provoking a domestic banking crisis. While this undoubtedly calls for more effective prudential regulation and supervision, it also calls for better accounting and disclosure rules, an end to government-directed lending, more effective national bankruptcy laws, and other reforms to reinforce market discipline over owners and managers. The IMF has been working in this direction by helping to develop and disseminate a set of best practices in the banking area. This effort at setting standards is very important, but equally important is ensuring compliance. Here the IMF can also play an important role through its policy dialogue with member countries.

More broadly, the Asian crisis underscores the fact that there is a wide range of institutional factors that can have an important bearing on countries’ economic performance. Certainly, sound domestic financial systems are one of them, but there are many others, including the transparency of government policy, a level playing field for private sector activity, a legal system that protects property rights and allows assets to move to their most productive uses, and a properly sequenced opening to capital inflows. For the countries at the center of the crisis, the importance of these factors is now painfully apparent. But they are important for other countries, as well. At the moment, we see some of them coming into play in Japan, as it seeks to overcome its current recession. Appropriate measures to boost domestic demand are surely needed, but so are steps to accelerate deregulation of the economy, and strengthen the domestic financial system. In this regard, the recently announced package of fiscal measures is encouraging, but it needs to be followed up with concrete action.

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What about Australia? Since the 1980s, Australia has been pursuing a far-reaching strategy of economic reform. As a result, the economy is now in its seventh year of sustained growth with low inflation, and last year the budget was close to balance. Moreover, after some serious difficulties in the mid–1980s, the banking system has been strengthened substantially, so that non-performing loans have fallen below 1 percent of total loans. Presumably, these are some of the reasons why Australia—which, now more ever, must be seen as an Asian economy—has not been drawn into the crisis, despite the fact that a relatively high proportion of its trade is with the affected countries, or with other countries in the region experiencing poor growth.

I would also note that Australia has played a very helpful role in helping to defuse the crisis. Australia has agreed to provide $1 billion each to the international financial packages in support of Thailand, Korea, and Indonesia; in fact, your country is one of the few that has agreed to participate in all three operations. Moreover, Australia understands very well the need to strengthen policies and performance on a regional basis. It was a motivating force behind the New Arrangements to Borrow and the creation of APEC. More recently, it has actively contributed to the formation of the Manila Framework Group as a forum in which the Asian and Pacific countries can encourage each other to pursue better policies and thereby complement the IMF’s multilateral surveillance over countries’ economic policies and performance.

In short, Australia has a lot to be proud of. But in my experience, Australians are not ones to rest on their laurels. Here in Australia, you sometimes say that yours is "the lucky country," but I prefer to think that a good part of this "luck" comes from your own efforts. Indeed, maintaining a competitive edge in the global economy requires energy, hard work, and thrift. In this regard, all countries need to update their institutional frameworks to improve efficiency, provide an environment conducive to initiative and risk-taking, and reduce the scope for rent-seeking. And so I would expect that Australia would continue to strengthen its economy by keeping on track with the government’s plan to achieve budget surpluses, and by moving forward with other economic reforms, particularly in the area of tax policy and labor market reform.

Tax reform must address the problems of a narrow and eroding tax base for indirect taxes and the relatively high income tax rates on middle income earners. Therefore, priority should be given to broadening the tax base, including by introducing a VAT-type tax on goods and services, and lowering marginal tax rates. As regards labor market reform, the 1996 industrial relations legislation was a step in the right direction. However, in the modern globalized economy, wage rates and labor market practices cannot be insulated from market conditions. While inevitably sensitive and politically difficult, further reform should concentrate on strengthening bargaining at the enterprise level and reducing the central role of both the Industrial Relations Commission and the complex system of "awards." In the same vein, I am sure that Australia will continue to use its influence to promote economic reform throughout the region and thereby help its neighbors reestablish the basis for sustained, high-quality growth.

Toward a new architecture

I have concentrated my remarks on what individual countries can do to strengthen their economies in today’s global economy. But in light of the crisis in Asia, the IMF and its member countries are also working intensively on ways to strengthen the so-called "architecture" of international financial system. At least three broad sets of issues are under consideration.

The first is how to make IMF surveillance over member countries still more effective. Here, it has been agreed that the Fund should give more attention to financial sector issues, the monitoring of capital flows, and the risks of contagion. We are also exploring how the Fund could give increasingly strong warnings to countries believed to be seriously off-course.Fund surveillance could also become the vehicle for disseminating internationally recognized standards, or "best practices," including those that might be developed by other institutions—for example, in accounting and securities regulation.

A second issue is how to increase the availability and transparency of economic data and information of economic policies. Here, the IMF has been requested to strengthen the standards it has developed to guide members in the release of economic and financial data to the public to include countries’ net reserve positions, short-term debt, and indicators on the stability of the financial sector. Members are also being encouraged to release the details of their policy commitments to the IMF and the Executive Board’s views on their economies.

A third major issue is how to involve the private sector in forestalling and resolving financial crises. The objective here is to discourage excessive risk-taking and to ensure that all creditors bear the consequences of their actions to the fullest possible extent. Various ideas are under consideration, including developing closer contacts between the IMF and private creditors, encouraging stronger national bankruptcy procedures, and introducing provisions in bond contracts to facilitate the debt restructuring, when needed.

Efforts are also under way to strengthen the IMF’s capital base and augment the special credit lines that the IMF could draw upon, if needed, to deal with a situation that threatens the stability of the international monetary system.

I would be happy to discuss these issues with you in greater detail, but alas, those remarks would fill a second speech.