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98/12

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Challenges Facing the Transition Economies of Central Asia

Address by Michel Camdessus
Managing Director of the International Monetary Fund
at a conference on "Challenges to Economies in Transition"
Bishkek, Kyrgyz Republic - May 27, 1998

Thank you, President Akayev, Chairman Sultanov, ladies and gentlemen.

It is a great pleasure to join you at this conference marking the fifth anniversary of the introduction of the som. I say this for two reasons. First, you have given me a most welcome opportunity to visit the Kyrgyz Republic, a country which, under the leadership of President Akayev, has been at the forefront of reform within the countries of the former Soviet Union. The introduction of the som, which we are commemorating today, was one of many courageous and forward-looking decisions that have contributed to your country’s economic progress.

Allow me to elaborate somewhat on that. The Kyrgyz Republic is now at a promising stage of its history. After several years of an extremely difficult transition, your country starts experiencing the benefits of its orientation toward a market economy. Not only has the dramatic decline in output been reversed, but for two years in a row growth of output has been around 7 percent, while the introduction of the som has been key in bringing inflation down from the destructive hyperinflation level of 1,259 percent, where it was in 1992, to the single digit level where it stands now, and you know that further progress is at hand. These achievements are still fragile and, in the framework of the new program on which we have just agreed, your government, Mr. President, wants to consolidate them, to make sure that the trends toward increased poverty are also reversed, and that the poorest in the country benefit particularly from the economic expansion of the years to come.

This is an ambitious but realistic program and, in visiting Bishkek today, I wanted to tell you and the people of this country our full determination to make a maximum effort to support this program and to convince the international community to join us in this endeavor. This is also a unique occasion to pay tribute, Mr. President, to your vision and leadership in conducting this transition, which not only has laid the grounds for a promising future, but has also been a source of inspiration for other countries in similar situations.

Second, your invitation also provides an excellent occasion to reflect upon the critical issues facing Central Asia. From the earliest days of the transition, the IMF has been providing policy advice, technical assistance, and financial support to help your countries develop efficient market economies and integrate themselves into the global economy. Thus, we have in some sense accompanied you during your "transition," sharing your pride in your achievements and your determination to overcome the problems you still face.

At the same time, however, the IMF is also in a continuous policy dialogue with its other member countries. So, our views on the issues facing Central Asia are colored not simply by our experience with your countries, or even by our involvement with transition economies in general, but by our experience in 182 countries at every stage of economic development, in every conceivable economic situation, and in every region of the world. It is from this broader perspective that I would like to discuss the issues facing your countries. Let me begin with a few words on the opportunities and challenges in the global economy and how various of our member countries have responded to them. Then I will turn to the implications for Central Asia.

Challenges in the global economy

It is frequently said that the world has entered the age of "globalization" or that we now live in a "global economy." But what does that really mean? For over fifty years, the world economy has been growing more closely integrated in terms of trade and capital flows. To a great extent, globalization is simply the continuation of that trend. But with greater freedom of trade and investment and new breakthroughs in telecommunication and information technology, markets have become much larger, more complex, and more closely linked than ever before. Moreover, capital now moves at a speed and in volumes that would have been inconceivable just a few years 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, of which nearly half went to Asia. Subsequent events have shown that some of those funds were not invested wisely. Nevertheless, 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 Malaysia, for example, the share of the population living below the poverty line declined from almost 50 percent in 1970 to less than 10 percent in 1995. 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.

But if globalization offers many opportunities, it also holds two major risks. The first can be seen in the recent experience of Thailand, Korea, and Indonesia, all of which have suffered major financial crises during the last year, when investors lost confidence in their economies and large capital inflows turned into massive capital outflows. Countries that attract large volumes of private capital are more vulnerable to sudden shifts in investor confidence, which can be very destabilizing to their own economies and have negative effects on other countries, as well. Indeed, some of your countries have felt a chill breeze from East Asia, as commodity prices weakened, conditions in international capital markets became less favorable, and some East Asian investors scaled back planned investments.

The second risk can be seen in the experience of many African countries. Countries that are unable to participate in the expansion of world trade or attract significant amounts of foreign capital risk becoming marginalized from the global economy and falling farther and farther behind the rest of the world in terms of growth and human development. This marginalization, in turn, poses the very real threat of economic stagnation and increasing poverty.

The challenge for all countries is how to make the most of the opportunities that globalization has to offer, while minimizing these risks. This is not an easy task. However, among the members of the IMF, there is a tremendous wealth of experience as to how countries can best meet this challenge. One purpose of the IMF is to help disseminate this experience as broadly as possible, so that countries can learn from each other’s successes and failures. In this spirit, let me turn now to the lessons of our members’ experience.

* * * * *

Ingredients of economic success

Experience shows that in order to be successful in the global economy, countries must first have properly functioning domestic economies. What does this involve? Let me mention three key requirements.

The first is to allow market forces to set prices and allocate resources so that the economy can operate efficiently. Progress in this area has been uneven in Central Asia, particularly in the agricultural sector, and private investment, labor productivity, output, and rural incomes have suffered. Countries that hesitate to liberalize agriculture, or indeed, other sectors of their economies, should consider the dramatic example of Vietnam, which went from being a net importer of about half a million tons of food annually in 1986–88 to being the world’s third largest rice exporter in 1989, following sweeping reforms in the agricultural sector.1 Today, Vietnam is still one of the world’s leading rice exporters.

Of course, one key aspect of improving resource allocation—as well as taking advantage of the opportunities in global markets—is to open the economy up to foreign trade and hence to international price signals and competition. However, these benefits of trade liberalization will only materialize in the context of a unified exchange rate and the removal of restrictions on current transactions.

The second requirement for domestic economies to perform well is a stable macroeconomic environment, beginning with a relatively stable price level. There is now nearly universal consensus that low single-digit inflation is a necessary condition for sustained and equitable economic growth. There is also wide agreement on the policies needed to achieve this objective—notably a disciplined fiscal policy that keeps government expenditure in line with government revenues, while providing for a satisfactory level of public investment in basic infrastructure and human capital and a well-targeted social safety net. In this regard, there is considerable scope for strengthening fiscal management in most transition economies—from improving tax systems and tax administration, establishing effective treasury systems, prioritizing public expenditure, and putting pension systems on a sustainable footing. Such reforms are essential, among other reasons to ensure that the fiscal position is consistent with a non-inflationary monetary policy and a sustainable level of external debt. Yes, countries must also manage their external debt wisely. One needs only think about the debt crisis in Latin America during the 1980s and the so-called "lost decade" of economic stagnation that accompanied it, or the problems of heavily indebted poor countries in Africa today, to see how excessive external borrowing—or borrowing on inappropriate terms—can compromise a country’s financial stability and economic growth for years to come.

Finally, for the private sector to fulfill its intended role as the main engine of growth and job creation, there is a third requirement, which for the most part is still missing here in Central Asia, and that is a suitable institutional framework that will give domestic and foreign entrepreneurs the confidence to invest. In particular, I would point to the need for:

  • simple and transparent regulatory systems—so that businesses won’t waste precious time and resources trying to find out what the rules are and how to comply with them; so that new firms can enter the market without complication or being driven underground; and so that foreign investors are encouraged to bring in their capital, technology, and skills;

  • effective legal and judiciary systems that protect property rights, enforce contracts, and help create an atmosphere of law, order, and personal security—so that domestic and foreign investors will expand their businesses and create new ones; and

  • tax systems that are simple and broad-based, with limited exemptions and reasonable and uniform rates—so that companies and individuals will not be discouraged from trying to fulfill their tax obligations; so that taxes can be more easily enforced; and so that governments receive the revenues they need to carry out their basic responsibilities in such areas as health and education.

Experience also shows that in order to make a decisive difference in the domestic economic climate, policies must be reasonably consistent and achieve a critical mass of reform, thereby convincing investors that reform is irreversible, and that the country is truly integrating into the international economy. Partial reform may not elicit much response if substantial impediments to economic activity remain in place.

As you may have surmised, meeting these three requirements implies a redefinition of the role of the State in the economy. In successful market economies, the State disengages from activities that markets and the private sector can perform more effectively, such as setting prices, allocating credit and other domestic resources and running commercial activities. Instead, it concentrates on carrying out a few core responsibilities well, such as upholding the rule of law, providing reliable public services, maintaining prudent macroeconomic policies, and establishing a fair and transparent regulatory framework for private sector activity. Of course, governments must also give their full attention to stamping out corruption in every form. These are all aspects of "good governance," which is an essential condition for saving, investment and sustained growth.

Lessons from East Asia

If these are the lessons of experience from developing and transition economies, what does the experience of the misfortunes of the "Asian tigers" imply for Central Asia?

First, it is worth noting that the reason why countries such as Thailand, Korea, and Indonesia were so successful economically for so many years is that they instituted many of the requirements I just mentioned—including macroeconomic stability, outward looking economic policies, and a high priority on human development—at a relatively early stage. So what went wrong? Put simply, 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 and the lack of sufficient exchange rate flexibility, which, along with implicit guarantees of support to banks and corporations, led to excessive external borrowing and exchange rate exposure, often at short maturities;

  • in the high degree of inappropriate government intervention the economy, including lending based on personal connections and government directive, which led to inefficient investment and a deterioration in the quality of bank balance sheets, while prudential rules were lax and banking supervision was weak;

  • in the lack of data and transparency, which concealed the extent of these countries’ problems—and not just to the rest of the world, but also to their own eyes. This led to complacency on the part of the authorities, a false sense of security on the part of foreign investors, and later when the facts became known, to market panic.

From this experience, I would highlight three points that are particularly relevant for countries in Central Asia and, indeed, for every other country that hopes to tap international capital markets.

The first point concerns the need to maintain sound macroeconomic policies, correct macroeconomic imbalances promptly when they arise, and continue with the structural changes needed to sustain macroeconomic stability and high quality growth. Even countries that appear to have reasonably sound policies must be vigilant.

The second point concerns the importance of sound domestic financial systems. In Thailand, Korea, Indonesia, and many other countries, we have seen the tremendous human cost of allowing delaying key structural reforms, especially steps to strengthen the domestic financial system. Overcoming a domestic banking crisis is a very costly undertaking. We don’t know yet what the price tag will be in East Asia, but I can tell you that the cost of the banking crisis in Chile, with all its indirect costs, exceeded 30 percent of GDP; the one in Venezuela, certainly more than 20 percent of GDP. Can you imagine the cost of this in terms of schools, health care centers, and basic infrastructure? The countries in Central Asia are in the process of reforming and restructuring their banking sectors; they should make sure that the systems they are creating are built on solid rock—not on sand—by establishing strong market incentives for prudent bank management and a framework of domestic regulation and supervision consistent with international standards.

The third point concerns the need for transparency. When governments are in the habit of providing the public with full information about their policies and the country’s economic performance, policymakers have more incentive to pursue responsible policies, and costly policy mistakes and disruptive financial crises are less likely to occur. Moreover, when the financial markets have reliable economic and financial data, they are better able to distinguish between countries that have sound policies and those that do not, and the risk that a crisis will spill over from one country to another is reduced. Transparency also contributes to a more responsible use of public resources for the public good and reduces opportunities for corruption.

In this regard, and let me be very candid here again, one cannot help but observe the similarities between the relationships that existed among enterprises, banks, and government in some East Asian countries under the system of "crony capitalism" and the tendencies one can observe—which still survive or start developing again—in a number of transition economies. As we have seen in East Asia, when the structure of ownership is not transparent, when regulation is inadequate and unevenly applied, when too many ad hoc decisions are taken, and when market forces are prevented from playing their normal disciplining role, serious imbalances and deadly inefficiencies can build up. And, once exposed, these problems can provoke an abrupt market correction.

* * * * *

So these are some of the lessons of experience from other IMF members that face, or have faced, many of the same challenges confronting your countries. These lessons are particularly worthy of consideration today, as we commemorate the introduction of the som. A good currency can only be beneficial insofar as it is strong and stable. And, of course, all of that depends on the quality of the macroeconomic and structural policies that underpin it. In this regard, my remarks today have mostly concerned what the transition economies of Central Asia can learn from the experience of other IMF member countries. But when I come back for the tenth anniversary of the som, I hope to bring a different message—not what your countries can learn from, say, the East Asian "tigers," but what other countries can learn from the success of the "snow leopards" of Central Asia.


1These reforms included liberalizing agricultural prices, introducing competition among agricultural trading companies, granting families and individuals long-term rights to land use, and removing internal barriers to trade. See: Vietnam: Transition to a Market Economy, IMF Occasional Paper no.135 (Washington: International Monetary Fund, March 1996).


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