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The Strait Times
March 4, 1999
The countries hit by the Asian financial crisis are reemerging after an economic tempest of unusual ferocity. While this has clearly been a very difficult period for the countries affected by the crisis -- and devastating for their people -- there are reasons to hope that the worst is now over.
The economic downturns appear to have bottomed out -- with signs of recovery already in South Korea. The currencies are much stronger despite turbulence in other emerging markets, and interest rates have fallen to below pre-crisis levels in South Korea and Thailand. Foreign investors are again acquiring a taste for Asian debt and equities, in part because of the progress the crisis countries have made in implementing reforms.
While the worries about the region may be easing, the debate about the crisis -- and the policy response -- continues. Certainly, the reaction to the International Monetary Fund's recent report on the crisis, "IMF-supported Programmes in Indonesia, Korea, and Thailand: A Preliminary Assessment" (available on the Internet at www.imf.org), would indicate that there is still plenty to be said about the events of the past 18 months, and, indeed, the period before Thailand devalued the baht in July 1997.
Journalists and editorial writers worldwide (including at The Straits Times) have been quick to respond -- taking the Fund to task for shortcomings both real and imagined, as well as praising elements of the report.
Such a debate is healthy, but it is important not to oversimplify the complex causes of the crisis or overlook the difficult issues that these events have brought to the fore. As the world community and international institutions develop the tools to head off future crises, or mitigate their impact if they occur, the lessons from Asia's economic distress will be revisited again and again.
To put the IMF's response to the crisis in context, it is essential to consider the forces that brought the disaster to a head in the first place.
The crisis exposed the weaknesses in the region's financial and corporate sectors. Ill-conceived policies towards short-term capital flows attracted a flood of money that swamped the already significant flows of more stable long-term investments going to those countries. Limited exchange-rate flexibility built a powder keg of unhedged currency exposures. Prudential and regulatory shortcomings exacerbated the problem of non-performing loans.
When the flow of short-term capital into the region reversed abruptly, the structural flaws became self-aggravating, and a vicious circle of currency depreciation and insolvency ensued.
Contrary to the "cookie-cutter" image that some pundits are so quick to attribute to Fund programmes, the policy response in Asia contained many novel elements. IMF-backed programmes gave exceptional emphasis to structural reforms designed to address the underlying fragilities, along with the macroeconomic policies to help stabilise the immediate crisis.
There is little doubt about the necessity of the structural reforms in general -- especially in the area of rehabilitating weak banking and corporate sectors. However, there is a need to examine such issues as the timing and content of specific reforms. It is important to recognise that the efforts of the Thai, Korean and Indonesian governments to address these issues are a fundamental reason that their economies are beginning to regain their footing.
On the macroeconomic side, higher interest rates were essential at the beginning of the crisis to stabilise exchange rates. The alternative of letting the exchange rate go, as some critics have advocated, would have led to a much deeper cycle of depreciation and inflation -- and the resulting wave of bankruptcies and collapse in demand would have been even worse than what actually occurred.
The policies pursued were tough medicine, but the illness demanded it. The results now evident speak for themselves.
Considerable attention also has been focused on the budget tightening contained in the initial Asian programme designs. When the programmes were launched -- well before the world had a sense of the severe market contagion and recession that would follow -- some spending cuts were envisioned. In large part, these were intended to accommodate the cost of financial restructuring.
The Fund has acknowledged that, like most observers, it misgauged the depth of the approaching recessions. But it is incorrect to leap to the conclusion, as many commentators have, that this brief period during which budget cuts were envisaged -- which was followed by significant fiscal easing as the depths of the recessions became evident -- had an appreciable impact on economic activity.
Contrary to some critics' assertions, the recessions were not the result of Fund-supported programmes, but were mainly due to the confluence of factors that required IMF intervention in the first place.
The lessons of the Asian crisis have a major bearing on future policies. But they are not the only issues that must occupy us, lest we be guilty of "fighting the last war". To forestall future crises, it is incumbent on the world community to also address the broader question of how to reform the international financial system.
One issue that demands immediate attention is the behaviour of capital flows. The fact that so many external creditors could pull their money out of the crisis countries at short notice was one of the key reasons the crisis grew and spread across borders. It also meant that any effort to address the crisis was crucially dependent on the market's reaction. While private investors holding longer-term assets incurred significant losses, those with short-term investments, notably interbank credit lines, could, and did, run for the exits.
Could the crisis have been contained had the authorities imposed some kind of involuntary debt rescheduling, accompanied by capital controls? This would have been difficult to achieve. Any hastily designed and heavy-handed attempt to keep private creditors in one country could have sent more fleeing from other countries, and might well have further reduced the pool of financing for emerging markets.
Asia's experience calls for careful consideration of possible ways to involve private creditors in preventing and resolving financial crises, as difficult as this may be in practice. There are several proposals on the table to begin to accomplish this, including new frameworks for debt workouts.
A related issue is the usefulness of capital controls in limiting short-term capital inflows before a crisis, and more generally, the appropriate pace and sequencing of capital-account liberalisation. We at the IMF are actively studying these issues.
The scale of financial support that governments and international institutions should provide in the event of a crisis must also be considered. We need to reassess the appropriate size and composition of official financing packages that will keep private creditors and their money engaged. But this also introduces some thorny issues, in part because of the enormous volume of capital flows in relation to the limited resources made available to international institutions. We also need to consider the possible moral hazard implications of providing sufficient financing to constitute a guarantee on short-term external debt.
Since the panicked withdrawal of foreign capital partly reflected real shortcomings in the knowledge of investors and creditors, there is a critical need for major improvements in the types of information provided by emerging market countries.
These reforms cannot be forced on countries; rather, they must spring from an understanding that transparency is in the best interests of healthy markets. The IMF and other organisations are working to set higher global standards for making economic information universally available.
Another important lesson from the crisis is the need to have in place safety nets to cushion the impact on the poor and vulnerable. A broad-based effort involving governments and the international community has seen to it that social assistance programmes have been put in place. But much more must be done -- now and in the future -- to strengthen their effectiveness in mitigating the impact of economic downturns on the poor.
The issues arising from the Asian crisis are vast and complicated, and the IMF by no means claims to offer all the solutions. What is needed is a cooperative effort by governments, international institutions and society at large to refine the agenda for reform, and to find creative and realistic solutions that can gain the backing of the world community. The IMF is ready to work together with interested parties -- and to listen to their ideas.
[The writer contributed this article to The Straits Times.]