Brazil and the IMF
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Indonesia and the IMF
Italy and the IMF
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Free Email Notification
by Michael Mussa
on the Interim Assessment
World Economic Outlook and
International Capital Markets
Monday, December 21, 1998, 9:00 a.m.
International Monetary Fund
MR. ANJARIA: Ladies and gentlemen, welcome to this press conference on the Interim Assessment of the World Economic Outlook and International Capital Markets. I'm very pleased to have here at the table Mr. Michael Mussa, who, as you know, is the Economic Counselor and Director of Research Department of the IMF; to his right, Mr. Flemming Larsen, who is the Deputy Director of the Research Department; and to his right, Mr. Graham Hacche, Assistant Director of the Research Department. To my left are Charles Adams, Assistant Director of the Research Department, and Gary Schinasi, Chief of the Capital Markets and Financial Studies Division of the Research Department.
As you know, the proceedings of this press conference and the report itself are under embargo until 11:00 a.m. this morning, Washington time. By way of introduction, let me just say that this report looks at three things. It reassesses and updates the World Economic Outlook in the light of recent developments. It sheds light on the turbulence that financial markets in emerging and mature economies have seen. And, third, it talks about shortcomings in private and public risk management systems that need to be addressed.
I would now like to invite Mr. Mussa to make some opening remarks.
MR. MUSSA: After the Russian devaluation in the fall--in mid-August, considerable tension and turbulence developed in several financial markets, first, forcing up interest rate spreads and cutting off new credit flows to emerging market borrowers, and then spreading to affect some of the deepest and most liquid of the world's financial markets, including sharp declines in industrial country equity prices, unusual volatility in yields in the highest grade government debt, widening spreads for lesser quality borrowers, a general rush to safety and drying up of liquidity, and sharp movements in key exchange rates.
Fortunately, conditions in financial markets have calmed down since early October, thanks in part to timely actions to ease monetary conditions by leading authorities in North America, Europe, and Asia. The Asian emerging market economies most caught up in the recent crisis, most notably Thailand and Korea, are making substantial progress with their stabilization and reform efforts, as evidenced by the strengthening of their exchange rates and equity markets.
With substantial support from the international community, Brazil has undertaken a forceful program to correct its fiscal imbalance and thereby help to stabilize its own economy and halt the spread of contagion elsewhere in Latin America.
More generally, interest rate spreads for emerging market borrowers have been declining, especially for those with the strongest fundamentals, and a resumption of capital flows to emerging markets appears to be starting.
In view of the significant events that have affected world capital markets since the preparation of the most recent editions of the Fund's International Capital Markets Report last summer and of the World Economic Outlook in early autumn, we are today releasing an Interim Assessment of these two reports which analyzes and assesses recent events. Mr. Larsen will say a little more about the outlook, and Mr. Adams will comment briefly on world capital markets.
Let me say at the start that we are seeing a calming in financial markets since last October, and because of this calming and the actions that have helped to produce it, here at the Fund we assess that the near-term prospects for the world economy are actually little changed from how we saw things in early September, when the previous WEO draft was put together. Indeed, the forecast for world growth in 1998 has been revised up two-tenths of a percentage point, while that for 1999 has been revised down three-tenths of a percentage point. So the net change over the two years combined is only minus one-tenth of a percentage point.
Within that aggregate, there have been some significant changes for individual countries. Among the industrial countries, most notably, the forecast for economic growth in Japan has been revised down a full percentage point to stand now at minus half a percent for 1999. And among the emerging market economies, the forecasts for Latin America have been revised down significantly, while that for China has been boosted somewhat, leaving the overall for the world economy essentially unchanged over the two years and only slightly down for 1999.
Now, let me emphasize that, as with any forecast, there are always risks surrounding that forecast. Those risks are both on the upside, particularly in the United States where, given recent strains in the third quarter and likely results in the fourth our forecast may be a little on the downside. I think also in Asia there is certainly at least the potential for those economies to recover more rapidly than we have allowed. In Latin America, by contrasts, I feel at this stage the risks are still modestly to the downside. Mr. Larsen will comment more specifically on some of those issues now.
MR. LARSEN: The key message in the report is that the worst of this crisis probably is now behind us. This is a judgment we have made with considerable caveats, and I think it is fair to say that we certainly do not believe as yet that we are completely out of the woods. We continue to see significant risks, risks that are overall for the world economy predominantly on the downside. The main risks and uncertainties can be briefly summarized.
There is considerable uncertainty about the speed of recovery of private capital flows to emerging markets. These capital flows have been running at extremely low levels in recent months. It is likely over the medium term that these flows will recover. There are very good reasons for believing that. But there is concern that the speed of recovery may not be quite as rapid as assumed in the predictions.
There is also a continuing uncertainty about the speed of recovery in Japan. We have seen very encouraging policy measures recently to speed up the restructuring and recapitalization of the banking system and also to ensure the maintenance of an adequate level of policy stimulus, both fiscal stimulus and monetary stimulus. But there is still uncertainty about the implementation of many of the measures and about the speed of recovery in Japan.
There are continuing uncertainties about the very uneven pattern of trade adjustment we have seen in the wake of the large shifts towards surpluses in the Asian crisis economies. By far the bulk of the counterpart to these adjustments in Asia have been felt by the United States. It has been a very welcome contribution to easing the adjustment process elsewhere in the world, but there is concern about the sustainability of the very large current account deficit that has built up for the United States.
There are also concerns--and these are related to the trade adjustment pattern--concerns about the risk of a resurgence in protectionist pressures. And there is concern about the sustainability of the rapid rebound we have seen in stock market prices in the fall following the earlier correction. These concerns also extend to the sustainability of the large imbalance that has been building up in recent years between private saving and investment in the United States. The sustainability issue concerns the likelihood that this imbalance will need to be corrected over the medium term. It doesn't need to be a swift and rapid adjustment, but I think there clearly is an issue that one will need to monitor closely over time because of the implications this could have for demand and output in the U.S. and, of course, also worldwide.
MR. ADAMS: Given that this interim report has been based on the developments in global financial markets, we've paid a lot of attention to trying to look at the nature and sources of the turbulence in global financial markets and to see what lessons we could draw about the sorts of policies and the sorts of factors that could minimize the risk of this sort of turbulence in the future.
On the nature and sources of the turbulence, the points we emphasize are that we had for several years prior to the Asian crisis a repressing of risk, a narrowing of spreads, and we had a buildup during this year of a lot of positions based on credit risk or based on risk spreads remaining low or narrowing. We had a buildup in the set of vulnerabilities. Come the events in Russia, the debt restructuring and the devaluation, we thought we saw a fairly global reassessment of risk, a reassessment of the value of risk, which set in motion a chain of reactions in terms of portfolio balancing, a changing of positions that was exacerbated by a high degree of leverage in the system.
Looking at the events in the broader context, we've tried to shed light on the factors giving rise to the buildup of vulnerabilities, and we note that there are three main lines of defense against the sort of financial turbulence that was experienced: the first is the private risk management schemes of financial institutions, which displayed shortcomings; and the second and third are to do with prudential oversight and financial market supervision. In all these areas, our system didn't work to prevent a buildup in leveraged positions which, come the events in Russia, gave rise to a period of severe turbulence.
As indicated, we think things are now beginning to stabilize, but these things by their nature tend to be somewhat fragile in the early stages, and we may still see some of this portfolio unbalancing and deleveraging continuing. But we are cautiously optimistic that the process that we've seen following the events in Russia is beginning to turn around and that we'll see, looking forward, a tentative but perhaps fragile firming of financial markets.
QUESTION: In the report you indicate that the Basle BIS sort of requirements in terms of capital may be perhaps not as sharply tuned for dealing with the sort of risks and risk management problems that we've seen. What would you suggest if there was to be an overhaul of the BIS requirements? Would you look for higher margin protection? Would you look for the sort of extra capital requirements that you sort of hint at in the report? Specifically, what would you advocate in terms of the bank supervision and regulation side?
MR. MUSSA: Let me respond briefly to that and then ask Mr. Schinasi to follow up.
First, I think it's important to understand that the Basle Committee has been meeting for a long time, and the process of developing their standards has been a continuing one. Over the past two or three years they have been looking carefully at the issue of capital standards, especially as they relate to growing off-balance-sheet activity on the part of banks--accounting for an increasing fraction of their total earnings--and which includes activity in the derivatives markets but is not limited to that by any means. One of the key issues is how can the capital standards and other standards coming out of the Basle Committee usefully be adapted to deal with the changing structure of the business of modern, large, internationally active commercia banks.
Certainly the events of the past summer and early fall--those associated with Long Term Capital Management's near failure and subsequent rescue--suggest that this is an area that does indeed require attention, and indeed I expect is getting that attention.
MR. SCHINASI: First, I'd like to point you to Box 3.6 which documents some of the reforms that the Basle Committee has been engaged in considering. And let me just point out three areas.
One is that some attention is being paid to the actual weights of the Basle Accord capital standard. Let me note two there. One is the weight on interbank transactions, which is 20 percent. In contrast, the weight on government obligations issued by some of the same countries is 100 percent. So there seem to be incentives within the Basle Accord--which have been recognized and which are being dealt with--which tend to shift activity to interbank lending. Chairman Greenspan himself has observed that that is pushing financial activities into parts of the financial safety net.
The second area that is receiving increasing attention is the fact that the 8 percent rule is a fixed rule over the business and credit cycles. And it's at the top of business and credit cycles when marginal lending becomes riskier and there's some feeling that more than 8 percent should be set aside. And the second aspect of that is that at the top of the cycle one should expect a turn-around in which credit quality generally, not just on the marginal loan but on average loans, would tend to decrease. Thus, it would make sense for banks to set aside more than 8 percent as they're moving up the credit cycle and the business cycle.
The third area where reforms are being considered is more general, and that is, there's a shift, as this rethinking of weights indicates, from rules-based to risk-focused capital standards. And there's a more general trend to looking at risk management systems and operational controls rather than trying to monitor each and every risk that a bank takes.
QUESTION: Mr. Mussa, I've seen that Italy has maybe the sharpest reduction in the forecast for GDP growth in 1998. It's downgraded from 2.1 percent to 1.3 percent. That is a very big reduction. Today the OECD also downgraded sharply the Italian GDP, and they suggested that Italy should reduce its pension spending. What's your view about this suggestion?
MR. MUSSA: I would ask Mr. Hacche to comment a little bit more on the revisions to the forecast for Italy. Let me emphasize on the pensions issue that this is a general phenomenon for many European countries. Not all European countries, but many European countries where public pension benefits are very substantial. And financing those pension benefits imposes a very heavy tax burden on the working population. This is particularly true in Italy at this stage.
While the situation improves a little bit over the next five to ten years or so, when we get into the second and third decades of the next century, the situation worsens again. Some projections would have the contribution rate rising to the order of 50 percent by 2030 and 60 percent by 2050 in order for the working population to support those who are retired. So the OECD, the IMF, many observers in policy institutes and academia and so forth have all concluded that the present level of pension benefits in these very high benefit countries is simply not sustainable over the medium and longer term.
Now, it's important to recognize that Italy has already taken some important steps toward reform of its pension system, and over the course of time, more will need to be done. It's not a problem that needs to be addressed all at once, and, indeed, it is not a problem that is best addressed all at once. It is a problem that is best adapted to gradually so that the level of pension benefits over time can be brought more into line with that which is capable of being supported by the actual working population.
Graham, do you want to say a little something about the forecast?
MR. HACCHE: I think the downward revisions for Italy for 1998 and 1999 are related partly, perhaps mainly, to the data we have seen in recent months which shows slower domestic demand, and weaker external contribution to growth than we were expecting. On the external side, the slowing in Asia and other emerging markets has perhaps had a larger effect than we thought. On the domestic demand side, the removal of the rebate on car purchases has had a larger effect. Also, short-term interest rates have been lowered somewhat more slowly than we were expecting. But I would draw your attention to the fact that we do see growth picking up in Italy next year almost to 2 percent, partly reflecting the recent reductions in interest rates by the Banco d'Italia and the further reduction that we expect in the next couple of weeks.
QUESTION: First of all, on Japan, you noted that it's one of the most significant downward revisions. I guess since late September, the Japanese Government has actually announced further measures to help the economy, and yet you have revised the outlook downward by a full percentage point for next year. I wonder if you could just explain that.
And, secondly, there was a press conference by Mr. Stiglitz of the World Bank about a month ago, I think, in which he said that, in fact, the IMF's recommendations to many of the countries affected by the crisis had actually perhaps even made the crisis worse by urging them to raise interest rates to protect their currencies. I wonder if you could comment on that criticism, which has been echoed elsewhere.
MR. MUSSA: Let me ask Mr. Larsen to say a little bit about the revisions of the Japanese forecast and how it relates to their policy measures.
MR. LARSEN: I think the way to look at the revisions for Japan is that if we had not had the recent policy announcements, we probably would by now have revised down the forecast even more. The downward revision reflects essentially what has happened very recently. We have seen a number of negative indicators. The Tankan business survey was more negative than expected. And we have, of course, also had to revise the forecast to take into account the very sharp appreciation of the yen that occurred in September. That in itself has a significant depressing influence on the economy overall and will require stronger growth of domestic demand in order to offset it.
But, as I said, there are a number of positive policy developments. There's a new budget announced today which we are in the process of interpreting and which may well give rise to a somewhat different assessment of the fiscal stance. But it too early to say yet. There are also a number of other things in the works that hopefully will get the Japanese economy restarted again in the course of 1999.
MR. MUSSA: It is clear that the World Bank, and, in particular, it's chief economist, Mr. Stiglitz, has had a different assessment of the desirable policy responses at the time of the Asian crisis a year or more ago and has made that point on several occasions.
Let me emphasize what I regard as the Fund view on that issue.
No doubt we understood that at the beginning of the crisis in Thailand, Indonesia, Korea, and elsewhere last summer--that is, the summer of '97--through the winter of 1998, that a tightening of monetary conditions, I'd say a raising of domestic interest rates, was, other things constant, going to slow these economies. And the tightening of interest rates was therefore recognized as being tough medicine.
The issue is whether it was desirable medicine. The way I like to explain it is if you have cancer, chemotherapy doesn't make you feel better in the short term, but it may, nevertheless, be essential for a successful cure.
And at the time in these Asian economies, a key problem for all of them was that the values of their currencies were depreciating out of sight. The Thai baht depreciated from 25 to the dollar to 55 to the dollar at its nadir. The Korean won went from a little over 8 to the dollar at one point to over 16 to the dollar. And the Indonesian rupiah went from 2,500 to the dollar to 12,000 to the dollar. So we faced massive depreciations of currencies, and to resist those depreciations, some firming of monetary conditions was deemed by us to be an essential part of the policy package.
Now, I would emphasize that we always conceive of that tightening of monetary conditions as a short-term measure at the height of the crisis, and the whole objective of the stabilization program is to replace the tightening of interest rates with the restoration of confidence that is brought about by other measures and developments. And that is exactly what we have seen in all of these Asian economies.
Their currencies have appreciated from their depressed levels of last autumn and winter. The Korean won this morning is trading above 1,200, well above its exceptionally depressed level. Even the Indonesian rupiah has appreciated to 7,500 to the dollar from a nadir of over 12,000. And the Thai baht has traded up now from a minimum of 55 to 35, 36 today.
And as confidence has been restored, not only have exchange rates appreciated, but interest rates have come down significantly in all of those countries, in Thailand and in Korea to levels that are now meaningfully below where they were before the crisis started. So our assessment is that the right policy was to tighten monetary policy in the short term to help stabilize the exchange rate and then, as confidence was rebuilt, to be able to back off the monetary tightening and see a recovery in exchange markets as confidence was restored. That is what we have seen.
I would note that our Executive Board today is resuming its discussion of a paper prepared by our Policy Review and Development Department assessing Fund-supported programs in the Asian economic crisis and comparing the policy reactions there to what was happening in other economies. That study, which will focus on this issue, among others, will be published probably early in the new year.
I should like to focus on the closing pages of Chapter III. There is some discussion about the role of central banks and the role of risk management at commercial banks, comments such as the role of banking supervisors is an issue for concern, bank executives didn't learn the lesson of the Mexican crisis, etc.
I wondered, given the criticism that the Fund has taken in the past 12 months, would it be fair to say that one of the messages from this report is, well, if you say we got it wrong, other people got it wrong and have room for improvement as well? Is that one of the messages here?
MR. MUSSA: That's not the way in which I would interpret the message. Whether or not other people made errors does not excuse any errors that the Fund may have made. That's not the point. The point is a quite different one.
We did see in financial markets in the late summer and early fall really extraordinary developments and turbulence. A degree of movement in key asset prices, including the U.S. treasury bond yield, the dollar-yen exchange rate, equity prices and so forth, that seemed, at least to us--and I think to most others--substantially out of proportion with the magnitude of the triggering events that appeared to underlie those financial market developments.
After all, the economy of the United States has in 1998 turned in what is in many respects the best performance we have seen in certainly the last three decades, and perhaps in this century. Why in the midst of exceptionally low unemployment and exceptionally low inflation and rising productivity do we suddenly see massive movements, 75 basis points, 65 basis points down, 40 basis points up, in the 30-year U.S. treasury bond yield? There's no big threat of inflation such as we saw in the 1970s and 1980s.
So it is a bit of a mystery and a concern that so much turbulence in what should be such large and deep financial markets appears not to have sort of fundamental causes which match the magnitude of the turbulence that we are observing. And that ought to be a cause of concern, a cause of concern in the private sector about how key financial institutions, not just large hedge funds but key financial institutions that lent money to hedge funds and other speculative investors and that were their counterparts in derivative contracts, how they are assessing and managing the risks that they are undertaking in their various financial operations.
That's an issue that needs to be looked at, most importantly by these private sector financial institutions themselves. I think it is a sign that all is not well that the senior management of at least one of the world's largest financial institutions had to resign in order to take responsibility for what must have appeared to them and to their board an inadequate system of risk assessment and risk management. And those questions need to be asked at other financial institutions as well: whether their risk assessment and risk management systems are really up to the task.
After all, if we had a larger fundamental disturbance, maybe the volatility would be even greater. So you want to take these types of events as a signal that you want to reassess what you're doing. The way I like to explain it is this. It was a great tragedy that the Titanic was sunk by an iceberg. But what if it had been sunk by an ice cube? It would cause you to wonder about your naval design principles and practices.
That is, I think, where the primary action is needed in the private sector. The official sector is a backstop to that. But there, too, I think the official sector--and it's not just the bank regulators, it's others much more generally, including we here in the Fund--who have some surveillance responsibilities and cannot be exonerated entirely from failing to see some of this crisis potentially coming.
MR. ADAMS: A couple of observations to build a little on what Michael Mussa has said.
The key issue to us is that we had a buildup in fragility, we had a buildup in vulnerability across a fairly large number of market players in the mature markets. We had with the Russian debt restructuring an event which produced some losses for financial institutions, but then produced this massive reassessment and repricing of risk. And as a result of that, we saw two things. We saw pressure in some of the most liquid and deep financial markets in the world. We saw emerging markets for some time cut out of international capital markets. We saw a sharp--and we saw a fairly severe reaction.
The substantive issue is how it is that we get this buildup in vulnerability so that we can get these very significant events. And the focus we have in the report is on seeking to identify the weaknesses, the shortcomings, that may have led to these vulnerabilities developing. That to us is the key, and we and many other people are looking at the particulars of, for example, private risk management as the key initial element in preventing these sorts of buildups, and also the role of public oversight of the financial system.
But this is a substantive issue, and we're trying to ask ourselves why it happened, what features of the financial system produced this, and we mentioned, among other things, the degree of leverage, the role of over-the-counter derivatives markets, and looking forward, what can we try and do to reduce the chances of systemic problems.
Now, the issue is not to reduce the chance of failure of particular financial institutions. If particular financial institutions make the wrong decisions, there should be losses. But one wants to reduce the chances of a situation where you can have a relatively small hedge fund, Long Term Capital, get itself into the situation where there are substantive issues about systemic stability. And it's in that constructive vein that we've addressed the issue of what might be the shortcomings and what might be done about them.
QUESTION: I have two questions. First, your projections for Brazil of negative growth of 1 percent for next year is still better than what we're hearing in Brazil and from a lot of investment banks. I'd like to ask you if you could tell us to what point is that sugar-coated just because the IMF has an ongoing program there.
Second, Mr. Larsen talked about the U.S. economy. If you could talk a little bit about what kind of policies should be put in place here next year to avoid the pitfalls that you talked about, specifically what you'd like to see in terms of interest rates in the U.S.?
MR. MUSSA: Let me say a word about Brazil and the Brazilian forecast. The minus 1 percent forecast is, of course, the forecast that is embodied in the Brazil program, and the way in which program negotiations proceed, you need to have a forecast for how the economy will perform in order to set some of the program targets and performance criteria. So this was the forecast that was laid out as the basis for program negotiations about a month and a half ago and really has not been revised since then.
It will probably need to be looked at at the time of the first program review, which will probably occur sometime in February of next year. We certainly are aware of the fact that since the time that this forecast was put together, private sector forecasts have in many cases been moved downward. I just saw one recently that was now at minus 2 rather than minus 1. So it would not surprise me to see a moderate downward revision of the forecast when we revisit it in a couple of months' time.
But we are not anticipating that Brazil is going to fall into an extremely deep recession, as characterized the experience of some of the Asian economies in 1998. I would, though, put the risk for Brazil and all of Latin America as being balanced to the downside vis-a-vis the forecast that we are releasing today.
MR. LARSEN: On the United States, you can see that we are projecting a slowdown, which has actually yet to begin really to take place, in real GDP growth from 3.8 percent in 1998 to 1.8 percent next year. This is a slowdown which we think is probably unavoidable. We also think that some slowdown in U.S. growth probably is necessary relatively soon.
It is, of course, impossible to say how early the turning point will occur or how abrupt it will be. But if one looks at the longer-term performance of the U.S. economy in the 1990s, it is clear that there has been a buildup of an imbalance between private sector saving and investment which is unlikely to be sustainable in the longer run.
I'd like to draw your attention very briefly to a figure, Figure 4.6 on page 104, which shows this very severe deterioration in the saving and investment balance. Our conclusion in the report is that over the medium term we are likely to begin to see a correction back toward a more sustainable position. It is impossible to predict how quickly that will occur or how sharp this adjustment will occur, but some adjustment probably will be needed.
We therefore do not think that the kind of slowdown in growth we are projecting for the U.S. economy, which would still leave the U.S. economy operating at very high levels of capacity utilization, would warrant any significant further easing of monetary policy. The easing that has taken place in the fall has been very useful to help restore calm in financial markets, but the advice in the report is for monetary policy now to remain on hold for the time being. Should growth decelerate much sharper than currently expected, there may be a case for revisiting the monetary stance, but for the time being the advice is to keep monetary policy on hold.
QUESTION: Malaysia seems to be defying the IMF's prescription for recovery by imposing things like capital and currency control, but yet the IMF seems to be showing that there seems to be a turn-around in demand. So what is the IMF projection for Malaysia for next year, and what impact do you think the controls will have on capital flows and FDI to the country?
MR. MUSSA: As noted on page 93, Table 4.6, the forecast for real GDP growth for Malaysia in 1999 is minus 2 percent versus minus 3.4 for Indonesia and plus 1 for Thailand.
I want to emphasize with respect to all of these forecasts for the Asian economies there is an unusually large degree of uncertainty. There is some evidence to suggest, particularly in Thailand and Korea, that things may be bottoming out, and if they do, the economies can come back fast, notwithstanding the fact that there remain some very significant financial and structural issues that will need to be addressed in those economies.
I think I would say the same is broadly true for Malaysia as well, though there is less evidence for Malaysia that we have yet seen the bottoming out. So that's on the negative side.
More on the positive side for Malaysia, if you look at that same table, you will see that Malaysia sustained 7.7 percent positive growth in 1997, whereas Thailand had slightly negative growth in 1997. So Thailand entered the crisis earlier than Malaysia did. I think it was also in somewhat worse condition when the crisis started than Malaysia was. So Malaysia is lagging behind Thailand in terms of its adjustment by about six months or something like that. And that's why Malaysia remained much stronger than Thailand in '97. We also think that it will be weaker than Thailand in 1999 because the phase of the adjustment process is simply a little behind the adjustment in Thailand.
Cumulatively, the downward movement of the Malaysian economy relative to its potential growth path we anticipate will be somewhat smaller than will characterize the experience of Thailand, again, reflecting the fact that the conditions at the start of the crisis or before the crisis started were worse in Thailand than in Malaysia. That being said, and given the difference in timing, the broad pattern of movement and adjustment of those economies is going to look qualitatively very similar.
What are capital controls going to do to that process? My assessment is that in the short term the capital controls are probably neither going to hurt very much, nor are they going to help very much. We have seen interest rates come down in Malaysia, but we've also seen them come down in Thailand and Korea. So it is not by any means clear to me that the capital controls are assisting very much in the adjustment effort. On the other hand, it's hard to see a great deal of evidence that they are in the short term doing an enormous amount of harm either.
There is a question, I think, for the longer term of whether because of the experience with the imposition of these controls, investors are going to be more reluctant in the future to bring capital into Malaysia because they recognize the potential that they'll be stuck because of the controls and will be unable to withdraw it. So it may well be that down the road Malaysia will look less attractive to foreign investors because they'll look back on this experience with controls and regard it as a negative.
In the end, it will be very, very difficult to figure out whether that has happened or not because in the volatility that characterizes the behavior of the growth rate of real GDP over a significant number of years, it's often difficult to ascertain whether an event like capital controls has, say, slowed the long-term growth rate by half a percentage point for a decade or not. But we'll need to address that question more down the road.
QUESTION: To go back to your analysis of the Japanese situation. To what extent is the Japanese recession affecting the state of recovery of the other Asian countries? Is it fair to assume that the Japanese offer of financial assistance, the Miyazawa Initiative, would compensate for the weakness of Japanese import demand? And to look at the other side of the coin, which your report does, to what extent is the slowness of the recovery of the other Asian countries affecting Japan's own recovery? Are we looking a vicious circle here, in other words?
MR. MUSSA: There is no doubt, to get to the last part of your question first, that there has been a mutual reinforcement of recessions in the emerging market economies of Asia and the recession in Japan. Because their trade balance has continued to improve despite the fact that exports from Japan have actually been falling slightly, there's been really a very sharp decline in imports, part of which is lower spending on oil and reflects other lower commodity prices, but also a sharp decline in the quantity of imports. And that has been affecting a number of other East Asian economies. At the same time, the weakness in the rest of Asia has helped to undermine possibilities of recovery in Japan, and they have reinforced each other.
That being said, the economic difficulties in Japan are not primarily the consequence of problems elsewhere in Asia, and the economic difficulties elsewhere in Asia are not primarily the consequence of recession in Japan. They reinforce each other, but they are not the fundamental cause of difficulties elsewhere.
Now, what happens on the downside can also happen on the upside. That is to say, recovery elsewhere in Asia will aid recovery in Japan, and recovery in Japan will aid recovery elsewhere in Asia. And this is true not only through the trade channel; it's also true through the financial channel.
One of the things that has contributed to economic difficulties elsewhere in Asia has been the withdrawal of Japanese private finance, particularly the withdrawal by Japanese banks of some of the credits they had previously been extending to the rest of Asia. At the same time, the weakening of Japanese banks as a result of the actual or implicit losses they've taken elsewhere in Asia has been one of the things that has contributed to the very negative mood in Japan. So, again, there's been a mutual interaction on the downside, and that interaction can operate in reverse on the upside if we can get the process moving upward simultaneously in both Japan and in the rest of Asia.
In that regard, the Miyazawa Initiative is, I think, a very useful one in order to provide an increased flow of official capital to East Asian economies experiencing difficulty with the capital flows. This can help ease the adjustment problems on the financial side for a number of these economies, and thereby contribute not only to their own recovery but also assist the Japanese economy in its recovery as well.
QUESTION: Mr. Mussa, a few minutes ago you went through the flow chart of macroeconomic adjustment as it happened in Asia, with tightened interest rates leading to a halt in the depreciation of a currency which would encourage the return of confidence and allow interest rates to go back down, et cetera, et cetera.
I wonder if you think that the progress of events in Brazil has occurred there in a timely fashion because they have had interest rates high for some time now. Last week, they made a massive adjustment in monetary policy there, and I wondered if you think that confidence has returned sufficiently to the Brazilian economy that that rate cut was warranted at this point in time.
MR. MUSSA: Well, you may recall the Brazilian authorities pushed up interest rates very sharply in October of 1997 when the real came under significant downward pressure in the wake of the attack on the Hong Kong peg. That was followed up by a number of fiscal measures. More were announced than were actually enacted, but significant fiscal measures were enacted in the latter part of 1997. And as a degree of confidence and calm was restored to Brazil, interest rates were brought down in Brazil in the first half of 1998. And while interest rates remained fairly high, there was a large flow of capital into Brazil and reserves of the Brazilian monetary authorities rose sharply.
Now, the Brazilian real came under significant downward pressure again in the wake of the Russian devaluation and default and the broader problems in world financial markets. Again, the initial response was on the monetary side, and monetary conditions were tightened very sharply in September and particularly October, with short-term interest rates being raised to the range of 40 or 50 percent at their peak.
With the re-election of President Cardoso and the announcement of a significant new program of fiscal adjustment, backed by a substantial international support package from the international community, there was a recovery of confidence in Brazil, and we saw that in a sharp decline in the magnitude of reserve outflows. Nearly $20 billion flew out in the September-October period, and that reserve loss slowed very dramatically in November. We also saw a significant recovery in the stock market in Brazil and other evidence of a restoration of confidence.
In that environment, and as we had all hoped, there was some latitude to begin to bring interest rates down in Brazil, especially after the first step of the fiscal adjustment package--the delayed reform of social security--was passed by the Brazilian Congress. So interest rates were reduced from the mid 40s to the high 30s by the early part of December, and then were reduced somewhat further over the next couple of weeks.
I don’t think the announcement last week should be overdramatized. What was announced was a range for interest rates, with 29 percent at the low end and I think 35 or 36 percent at the high end, a range which is supposed to prevail at least through the end of January.
How much further down it will be prudent to move and how fast within that range, or whether it may be necessary at some point to push interest rates up somewhat within that range, will, I think, depend upon the state of confidence in the Brazilian economy, and particularly in Brazil's policy measures. In that regard, the failure of the Brazilian Congress to pass another part of the fiscal reform package, social security reform that relates to public servants, definitely was not confidence building, and it will be absolutely essential for the Brazilian authorities first to find substitute fiscal measures in the short term to replace that component of their fiscal effort, to push through hopefully that component of the fiscal effort at a later stage, but most importantly, to push through the remainder of the fiscal program, which is the bulk of it, as soon as possible.
As that is done, and as confidence builds further, there will be the capacity to reduce interest rates further to more moderate levels. But there needs to be that balance between the building of confidence backed by the forceful implementation of the reform and adjustment program that really provides the room for interest rates to be reduced, as we all hope they can and will be.
QUESTION: You have already commented extensively on Brazil. Could you please explain a little bit more about why have you reduced so significantly the outlook for Latin America in general and maybe some of the other countries like Mexico and Chile and Argentina?
MR. LARSEN: The general revisions in this report for Latin America, beyond Brazil, reflect a number of factors, including the internal trade linkages within the region, the projected slowdown in growth in the United States, the higher rates of interest on foreign financial flows that we saw in the wake of the crisis. These have come down since September. They have come down significantly, but they still remain much higher than they were before the August events. So the cost of foreign financing and the variability of foreign financing is a negative factor for Latin America.
Recent developments in commodity prices, including oil markets, are also affecting a number of countries in Latin America adversely and will affect domestic demand and the level of imports that can be sustained. In addition, we're seeing throughout the region a number of policy measures that are needed to reduce vulnerabilities to shifts in investor sentiment. These measures are needed in order to strengthen medium-term growth prospects, but in the short run, as we have seen in Brazil, such measures may have an adverse impact on domestic demand.
So all of these factors contribute to the downward revision, and I should add that the risks for Latin America are probably on the whole on the downside.
QUESTION: I'm a bit surprised to find that in today's outlook forecast Korea would experience another minus growth next year, while Mr. Camdessus and Mr. Fischer publicly said that Korea would experience positive growth next year. What happened? Today's report now says Thailand will be the only country to experience recovery next year.
Another question relating to that: Do you agree with Mr. Stiglitz’s diagnosis that the recovery pattern of the Korean economy will follow a U-shape rather than V-shape?
MR. MUSSA: It's important to understand the forecasts that are reported are reported in the form of year over year forecasts. So it's the average level of 1999 in comparison with the average level of 1998. So, for Korea, the forecast says that the average in '99 will be 1 percent below the average in '98, and for Thailand it will be 1 percent above.
For both of those economies, we believe that during 1999 the economy will move upward, and so if we compared the fourth quarter of '99 with the fourth quarter of 1998, both Korea and Thailand would show an upward movement of the economy. We think both economies are bottoming out.
Now, recall also that Thailand was the first economy that was hit by the crisis in July of 1997, and they had negative growth for 1997 as a whole because their recession really started in the third quarter of 1997. In Korea, the recession didn't start until the first quarter of this year. So we think Thailand is a few months ahead of Korea in terms of the phase of its cycle. And it is that which accounts for the difference between the plus 1 and the minus 1.
That being said, I don't think the difference between those two forecasts is worth very much. In contrast to Mr. Stiglitz, I am an advocate of the V view, that once the economy hits bottom, the turn-around can be pretty fast, even though a lot of structural problems are going to remain.
Keep in mind Mexico, where the legislature, just last week, passed the legislation to deal with the cleanup of the banking system. Mexico had a crisis in 1995. Real GDP fell 7 percent. Then it bounced back 6.5 or 7 percent in 1996 and 1997 and 1998. So Mexico had this kind of V-shaped recovery, notwithstanding the continuation of problems in the financial sector.
Now, Mexico had the benefit of being able to sell--export--into a very open and very expansive U.S. market. Korea faces an external market environment that is not nearly as favorable to the recovery of its economy. So I'm not expecting necessarily a Mexican-style reversal. But the Korean economy, which has been consuming its inventories of goods very rapidly, can get a significant turn-around in the economy this year just from the inventory balance.
I think minus 1 at this point for a year-over-year forecast is plausible. But plus 2 or plus 3, even on a year-over-year basis, should not be excluded at this stage as within the range of possibility. It is very important, however, to stop the down and start the up.
QUESTION: A year ago we were sitting in this room talking about having seen three bailout programs go through, and your report at that time--the second interim assessment ever the IMF had done--predicted no recessions for any of those three countries. Now we are seeing massive recessions this past year. I'm wondering if you're concerned about any credibility--or lack thereof--these numbers may have, given your prediction last December.
MR. MUSSA: Well, in the October WEO, we published the chart which showed not only our forecast but also the consensus forecast, that is to say, what outside private forecasters were forecasting about the Asian economies as we move through the crisis. And as of January of this year, with the exception of Thailand, where the private forecast was already in negative territory, the forecasts for the other Asian crisis economies were still at zero or slightly positive. So basically the Fund wasn't getting it any more wrong than was the average of outside forecasters. Clearly, the depth of the crisis has surprised all of us vis-a-vis what our expectations were a year ago on this date.
That being said, I would also emphasize, as I said at that time, that our judgment was that the risk in the forecasts, particularly for Asia, were substantially on the downside at that point in time.
I do not make that statement now with respect to the world economy. I think the balance of risk is on the downside and we can identify what some of those risks are--if there should be a major correction in stock markets in industrial countries, if there should be a major depreciation of the U.S. dollar, if we should fail to see a significant resumption of capital flows to emerging markets. Those are all risks that might materialize. I would also note that there are risks on the upside. At this stage, our forecast for the U.S. economy would envision that if the economy grew at a constant rate on a fourth quarter to fourth quarter basis, that growth rate would be only 1 percent. That's probably a little bit low. Indeed, it's not only probably a little bit low; it is significantly below the average of external forecasts.
As I emphasized in response to the last question, I certainly see the potential in Asia for the turn-around to be significantly larger and more rapid than we have allowed for in our forecast. There is some downside as well, but there is also, I think, a meaningful upside for Asia, including Japan, relative to our present forecast.
The two regions where I think the balance of risk is pretty clearly on the downside are Latin America and the oil and other commodity exporters, where the recent weakness in world oil prices is certainly an important negative. But when you add the sizes of those economies together, their overall contribution to world GDP is comparatively small. And while the decline in oil prices has clearly negative implications for growth in the oil-exporting countries, it has positive implications for real income and growth in the oil-importing countries.
So a forecast on the basis that we put it together with our purchasing power parity-adjusted exchange rate assumptions, a forecast for world growth at this stage for 1999 of around 2 percent is one that I think reasonably well balances the risks on the upside and on the downside, recognizing that if there were some bad things that might happen but have not happened, then that situation could change. But I think our forecast has to be based on where the stock market is, where the dollar is, not on where it might be.
One of the reasons why it's important to be aware of the risk is that policy is not inert to emerging developments in economies and in financial markets. We have seen, I think, a forceful indication of that in the past three months. If policy had not responded to the types of conditions that were developing in world financial markets in September and early October, this interim assessment of the World Economic Outlook and world capital market developments would look considerably darker than today's assessment does.
IMF EXTERNAL RELATIONS DEPARTMENT