The IMF's Role in Asia: Part of the Problem or Part of the Solution? Remarks by Thomas C. Dawson, Director, External Relations Department, IMF
July 10, 2002
The IMF's Role in Asia:
Part of the Problem or Part of the Solution?
Remarks by Thomas C. Dawson
Director, External Relations Department
International Monetary Fund
Prepared text for remarks at the Institute of Policy Studies and Singapore Management University Forum
Singapore, July 10, 2002
1. Thank you for the invitation to be here today. I'm happy to get away from the United States for a few days and get a break from all the talk of crony capitalism, lack of transparency, collapsing asset values, and large current account deficits. What a difference five years makes! It is the United States that is going through a time of soul-searching and adjustment, while East Asia appears to be back on track (though I am aware that Singapore, having survived the Asian crisis in relatively good form, has had a tough time the last couple of years as a result of the global economic slowdown).
2. Let me turn to the theme of today's event. Is the IMF part of the problem or part of the solution? I know it would make my talk quite interesting for you if I said that it is part of the problem, but I'm not ready to retire from the IMF just yet. It would also not be an accurate statement, given the many changes the IMF has made in recent years in the way it does business.
3. Many of the changes I'll describe were undertaken in response to the lessons learnt from the experience of the Asian crisis. This crisis tested the IMF as never before. Though we had issued, in private, several yellow flags warning Thailand of an impending crisis, the extent of the downturn in Thailand, and the speed and virulence with which the crisis spread to other countries in the region, was not forecast by us or anyone else. Many questioned our advice to the crisis countries on the appropriate fiscal policy and monetary policy to follow, and the latter remains a topic of intense debate to this day. Some of the conditions attached to the IMF-supported programs were criticized as being so extensive that they strained countries' capacity to implement reforms and tested the bounds of the IMF's expertise. In short, almost every aspect of our core operations came in for scrutiny and criticism.
4. Let's begin with the causes of the Asian crisis. As work by many scholars, including Professor Tan, has shown, the crisis was the result of the interaction of several factors. According to some, one factor was the zeal shown by the U.S. Treasury and the IMF in encouraging countries to open up to short-term foreign capital in the mid-1990s. These critics say that the entry of foreign capital into, and the subsequent hasty exodus from, economies whose financial and supervisory structures were ill-equipped to regulate and absorb the capital was devastating.
5. Is this a valid characterization? It's useful to recall a bit of history first. When the IMF was created in 1944, its founders envisioned a world in which trade was free but in which the restrictions on movement of capital across countries then in place were to be retained. In the jargon, current accounts were to be open, but capital accounts highly regulated. Capital account restrictions were considered necessary to support the "Bretton Woods system", the system of fixed exchange rates then in place. There is no denying the vision of the world being promoted by the IMF in the mid-1990s was different: at the 1997 IMF-World Bank meetings the proposal on the table was to amend the IMF's articles of agreement to give it jurisdiction over the liberalization of capital movements.
6. But while the popular characterization of a greater push toward capital account liberalization is broadly correct, it is inaccurate in many important details. The IMF did not encourage countries to liberalize short-term flows through the banking sector, which is what turned out to be the Achilles Heel during the Asian crisis. And many countries liberalize for their own reasons rather than as a consequence of external prodding. Thailand, for instance, was keen to have Bangkok emerge as an international financial center like Singapore and Hong Kong; an editorial last week in the Bangkok Post noted that "it was the (Thai) Democrat party that opened up the Pandora's box with the establishment of the Bangkok International Banking Facility, a pompous name for a good idea that went wildly wrong."
7. Nevertheless, as a result of the criticism received during and after the crisis, the IMF is more vocal in pointing out the risks of rapid capital account liberalization. While such cautionary notes have always been present in IMF advice, today they are much more likely to be given greater prominence. For instance, six weeks ago, although unnoticed by anyone in the international media but the Dow Jones newswires, we advised Sri Lanka against opening up its capital account until its financial sector was further strengthened.
8. As I noted, we were surprised by the speed and virulence with which the crisis spread to many countries in the region. The experience revealed the IMF had not kept up with the rapid developments in international capital markets, a deficiency it has tried to rectify through a number of steps taken over the last couple of years. We now have a International Capital Markets department that issues a quarterly Global Financial Stability Report on risks and vulnerabilities in these markets. Our management and senior staff now meet for an informal but regular dialogue with representatives of internationally-active private institutions through the Capital Market Consultative Group. CMCG meetings have taken place in various financial centers around the globe, including in Asia.
9. Better monitoring of international capital markets is just one of the steps through which we hope to reduce the incidence of crises. Other measures include a new program to better identify risks and vulnerabilities in financial sectors and development of standards and codes that assess how well countries are measuring up to international benchmarks.
10. A more thorough health check-up of the financial sectors of our member countries is being conducted through a new program,. It's called the Financial Sector Assessment Program (FSAP) and it's conducted jointly with the World Bank. To supplement the expertise of our own staffs, the program makes use of outside experts, whose knowledge and judgment provides an element of international peer review.
11. Our work on standards and codes seeks to provide a stronger basis for investors to make judgments about the allocation of private capital. The IMF has begun producing Reports on the Observance of Standards and Codes (ROSCs), which aim to enhance the coverage of institutional issues, in particular on data dissemination, fiscal transparency, monetary and financial policy transparency, and financial sector issues. We have already made considerable progress—as of end-March, over 200 ROSC modules had been completed for over 70 countries (including 33 for APEC members), three-fourths of which had been published.
12. We are also taking steps to resolve faster crises that do occur. There are three parts to our efforts to strengthen the framework for crisis resolution. First, we are trying to reach better-informed and more systematic judgments about debt sustainability. This is essential for deciding whether a major debt restructuring, possibly involving a substantial write-down of claims, is called for; or whether it is appropriate for the Fund, in conjunction with others, to provide financial support for policy measures to help restore confidence and catalyze the resumption of private capital inflows.
13. Second, we are working to establish a clearer definition of the conditions for and limits to access to IMF financing. This is a complex issue, but ultimately we cannot escape the fact that the IMF is not a global lender of last resort with the ability to create liquidity by issuing money. Some participants in this debate would like to establish quantitative limits on IMF financing, while others—including many in emerging markets-believe that this would not be appropriate, in view of the widely differing circumstances that countries may face.
14. Whatever the outcome of this debate, it is clear that the IMF's resources are limited. Hence it is useful to regions to develop some mechanisms for self-help, as Asian countries have increasingly been doing. The IMF supports these efforts. Our deputy managing director, Mr. Sugisaki, said in a speech at the APEC meeting in Beijing in May that "the numerous efforts underway to strengthen regional economic and financial cooperation in Asia, such as APEC itself, the Manila Framework Group, ASEAN, and the "Chiang Mai" initiative also can play a very useful role in helping to foster regional and global financial stability." These initiatives promote the exchange of information and policy dialogue among countries, which is a useful complement to the efforts of global institutions like the IMF.
15. Third, for cases where debt has become unsustainable, we are trying to develop ways to facilitate debt restructuring without unnecessary destruction of asset values or economic disruption. More ambitious use of collective action clauses will almost certainly be an important element in the solution, and we are actively engaged in an effort to design model clauses for this purpose. But as the use of collective actions clauses alone is unlikely to be sufficient, Anne Krueger has put forward a complementary proposal for a new Sovereign Debt Restructuring Mechanism (SDRM).
16. Turning now to our macroeconomic advice during the Asian crisis, one feature that has drawn a lot of attention is the belt-tightening recommended to Thailand at the start of the crisis. It is worth recalling that in July 1997, Thailand was still expected to post reasonable growth, it had a huge and growing current account deficit (more than 8 percent of GDP), and it faced large, though as yet unrecognized, fiscal liabilities to recapitalize the financial system. It was against this background that the IMF recommended a roughly-unchanged fiscal position. However, once the scope of the crisis in Thailand and in the region became evident, we quickly changed course. Indeed, IMF-supported programs in Thailand and other crisis countries were soon marked by large budget deficits, in part because of increases in spending on social safety net programs. As a result of the experience during the Asian crisis, our fiscal policy advice these days is much more attuned to the need to allow automatic stabilizers to work and to shield vulnerable segments of the population from the effects of the financial crisis.
17. The more acrimonious debate is on the appropriateness of the IMF's advice on monetary policy during the Asian crisis. The IMF's position that a temporary increase in interest rates may be necessary to restore financial stability during a crisis continues to have its supporters. As Larry Summers noted recently, "when a country's exchange rate is declining rapidly because capital is trying to leave the country, and the country's financial institutions are in real trouble, there is a fundamental conflict between restoring external confidence by raising interest rates and providing for financial repair through increased liquidity. It's a classic problem of a single instrument and multiple targets. Confidence is widely recognized as essential in combating financial crises."
18. Others have taken similar positions. Rudi Dornbusch for instance says that "investors will take confidence and bring money back when they see fiscal conservatism and high interest rates. Do that for a few months and you are on the right track." Our former chief economist Michael Mussa said in his typically colorful language that those who advocate lowering interest rates at the onset of a financial crisis are smoking something "not entirely legal". I used to think Mussa's comment could not be topped, but a couple of weeks ago our current chief economist Ken Rogoff ably rose to the challenge.
19. The debate over this issue has launched a thousand doctoral dissertations. Ph.D students and their professors have been studying the relative costs of higher interest rates versus exchange rate depreciation. To the extent that there is a professional consensus on this topic at the moment, it is that the costs of letting the exchange rate go are much higher than that of a temporary increase in interest rates. The issue is far from settled, but clearly what's needed is honest debate and a closer look at the empirical evidence, not polemics.
20. Let me conclude by discussing the changes the Asian experience has had on IMF conditionality, the conditions that countries are asked to fulfill in order to get and retain access to IMF funding. Exactly one year ago, the Japanese Ministry of Finance and the IMF convened a conference in Tokyo which brought together many of the key players during the Asian crisis—on the IMF's side Stan Fischer and several senior staff, on the Asian side several of those who had been involved in putting together the IMF-supported programs during the Asian crisis.
21. Looking back on their experience, some of the Asian policymakers wondered if all the conditions had been necessary or effective. The Philippine central bank's Cy Tetangco—who I've had the privilege of knowing for some years—noted that with its record of 20 IMF programs in the last 40 years, the Philippines was a "veteran" in negotiations with the IMF. While acknowledging the overall benefits to the Philippines of IMF assistance and conditionality, Tetangco pointed out that the 1998 program had over 100 conditions in 8 areas. Some of them, he thought, were critical to helping the Philippines weather the crisis; but many others were not or were, in any event, better handled by the multilateral developments banks than by the IMF. (See the full text of Mr. Tetangco's remarks at http://www.imf.org/external/np/pdr/cond/2001/eng/sem/071001at.htm.)
22. In the case of Indonesia, Mr. Boediono (currently the country's Finance Minister) said that "perhaps the dismantling of the clove monopoly and the rationalization of the national car and airplane industries could have been postponed until our head was above water." (See the full text of Mr. Boediono's remarks at http://www.imf.org/external/np/pdr/cond/2001/eng/sem/071001bo.htm).
23. As a result of input of this kind from people whose opinions we highly value, and as a result as well of our own internal assessments, we have been moving in the direction of streamlining IMF conditionality. The intent is to have fewer and less intrusive conditions and to limit them to areas critical to achieving the goals of the IMF-supported program.
24. We have also being looking into the possibility of using what is called "outcomes-based conditionality", in which the disbursement of IMF money is conditioned on the attainment of certain outcomes. This could help avoid micro-management by the IMF and give the governments somewhat greater flexibility in exploring alternate policies to achieve agreed goals. This might address another of the points made at the Tokyo conference. Some participants there called for IMF programs to be flexible enough to allow countries some choice in how to go about achieving commonly-agreed goals, noting Deng Tsiao-Ping's advice that it does not matter whether the cat is black or white, as long as it catches mice.
25. The way the IMF has gone about this so-called "conditionality review" illustrates the way the Fund has increasingly been carrying out its reforms. We have encouraged open debate on conditionality by holding conferences in Tokyo and other locations throughout the world. We have also invited comments through our website from interested stakeholders everywhere (http://www.imf.org/external/np/pdr/cond/2001/eng/collab/071701.pdf). And we have relied, of course, on the wide experience of our own staff, and the judgments of our Executive Board, on how to make conditionality more effective.
26. Many of the changes I've described are of fairly recent vintage; so I do not want to claim that they have transformed the IMF's way of doing business completely as yet. But I hope they at least convey the sense that the institution is trying very hard to change, and trying very hard to be part of the solution to Asia's challenges.