Economic and Financial Situation in Asia: Latest Developments - Background paper prepared for presentation by Michel Camdessus

January 16, 1999

99/1 Background paper prepared for presentation by
Michel Camdessus, Managing Director of the International Monetary Fund
Asia-Europe Finance Ministers Meeting

Frankfurt, Germany, January 16, 1999

I.  Introduction

In the year after the Asia-Europe Finance Ministers Meeting in Bangkok in September 1997, the serious, but apparently isolated, crisis faced at that time by Thailand was followed by worldwide turbulence. Situations of similar severity developed elsewhere in Asia, and Russia's unilateral debt moratorium in August 1998 led to a broader increase in risk aversion among financial investors, and to the drying up of private financial flows to emerging markets. Fears arose that crisis would spread to several major emerging market economies in Latin America. At first largely insulated, the industrial countries also began to feel the effects of the crisis during the third quarter of 1998, which together with signs of deepening recession in Japan, gave rise to concerns about a global credit crunch. By the time of the IMF/World Bank Annual Meeting in October 1998, fears had escalated that the current economic slowdown might continue to widen and deepen in 1999.

By the end of 1998, signs were emerging that the worst of the crisis in Asia was over, and that conditions were emerging for renewed growth later in 1999. The key challenge now is how to ensure that these tentative signs of recovery can be turned into a sustained recovery of strong high-quality growth.

After a brief review of recent global developments (Section II), this paper assesses Asia's programs, performance, and prospects (Sections III and IV). Finally, noting that Asia was the first to encounter the effects of the crisis, and has for some months begun to show positive responses to the policy programs, Section V explores the characteristics of the revitalized Asia that may emerge from this experience.

II.  Recent global developments

Although a number of downside risks linger, the risk of worldwide recession was diminished by several positive developments during the last quarter of 1998, most of them considered policy actions by countries around the world, which helped to restore a measure of calm to financial markets. These actions include:

  • Easing of interest rates by central banks in most industrial countries;

  • New policy measures in Japan to address banking sector problems and announcements of further fiscal stimulus;

  • Commitments by Brazil to a program to address its economic imbalances with extensive support from the international community, agreed in mid-November;

  • Continued progress with stabilization and reform in the Asian crisis countries suggesting that the conditions are emerging for a recovery of growth;

  • Progress toward implementing the IMF quota increase, the activation of the New Arrangements to Borrow, and the Miyazawa Initiative to provide additional assistance to the Asian crisis countries;

  • The proposal by G-7 Finance Ministers and Central Bank Governors, in their end-October statement, to enhance financing facilities in the IMF and World Bank to help ward off financial market contagion, along with their reaffirmed commitment to move forward with the agenda to strengthen the architecture of the international financial system.

Overall, therefore, there is some evidence that conditions in capital markets have eased since early October. But there are still signs that perceptions of risk are considerably greater than has been normal in recent years. These conditions are reflected in the IMF's latest projections1 that point to growth in both 1998 and 1999 of about 2 1/4 percent, well below the strong growth of previous years, followed by a recovery to about 3 1/2 percent in 2000.

Even if the risk of recession has abated, the international community still confronts an imperfect international financial system, some elements of which have not been adapted sufficiently to keep pace with the rapid evolution of the markets in recent years. The Asian crisis demonstrated clearly that, in addition to problems in the countries themselves, the international system still lacks many of the standards and the transparency that characterize well-developed financial markets at the national level.

III.  The Asian Crisis, Programs, and Responses2

1.  The background revisited

As a broad generalization, the crises in East Asian countries were the result of interaction among shortcomings in the global system, flawed national financial systems, and deficient corporate and public governance. As global financial markets developed, especially in the early 1990s, capital was attracted to East Asia in large part because of its exceptional record of growth and macroeconomic management. However, serious weaknesses that had been concealed in part by the magnitude of the flows, and in part by the inadequacy of risk assessment by foreign creditors and weak supervisory practices in some creditor countries, eventually came to light with the onset of the crises.

The conjunction of these long-term trends led to the most critical weakness—the immediate cause of the crisis—the accumulation of very large amounts of short-term debt. In the years prior to the crisis, large capital inflows contributed to a variety of problems including overinvestment, inflated domestic asset prices and, deteriorating loan quality. These weaknesses, in turn, reflected more fundamental problems, including weak domestic bank supervision and regulation, a history of political interference and the lack of sound commercial standards in the allocation of credit, and pervasive explicit or implicit government guarantees. Short-term inflows were also drawn in by the perceived implied guarantee represented by the exchange rate regimes that were viewed as de facto pegs.

Against this background, the way in which capital flows were liberalized contributed to financial sector weakness: banks and corporations gained ready access to large amounts of short-term external borrowing that was not adequately monitored by authorities, while longer-term capital flows were being liberalized more gradually and deliberately. In short, the countries had become highly vulnerable to sudden shifts in investor sentiment.

The domestic vulnerabilities came to a head as growth slowed in 1996, largely as a result of adverse terms-of-trade shocks, a loss of competitiveness associated with currency pegs that were maintained in the face of a sharp dollar/yen appreciation, declining export demand, and growing over-capacity in certain sectors. In Thailand, which also had a relatively large fiscal imbalance, the developments were reflected in a widening current account deficit. Policy responses in early 1997 were not adequate. The growth slowdown, in turn, was reflected in sharp declines in equity and property prices, which aggravated financial sector weaknesses and acted as a further brake to growth. Finally, the crisis began in the financial sector because of excessive maturity mismatches in balance sheets.

One striking feature of this episode was the speed and virulence with which crisis spread through the region, and threatened to extend worldwide. Four influences may explain this phenomenon: (i) common factors in the external environment, specifically the features in the global financial system that led to the large flows of volatile capital to the region; (ii) the spillover effects from trade and financial linkages among the countries; (iii) a true contagion effect, as the crisis in one country caused investors to reassess the fundamentals in other countries; and (iv) a number of unexpected exogenous factors, including weaker terms of trade and the deepening of the recession in Japan.

2.  Basic strategy of programs

Since the countries faced an immediate liquidity crisis coupled with profound structural problems, the programs required a comprehensive focus embracing structural and macroeconomic policies:

  • First, structural reform, particularly in the financial and corporate sectors, assumed a central role. While clearly onerous in such difficult economic conditions, structural reform was essential to address the root causes of the crisis, to restore market confidence, and to set the stage for a sustainable resumption of growth.

  • Second, macroeconomic policies were designed initially to stabilize the economy and subsequently to support economic recovery. Monetary policy aimed to prevent a spiral of depreciation and inflation; once a measure of stability had returned to exchange markets, interest rates began to decline. Fiscal policy aimed to complement monetary policy, and to make room in the budget for the costs of bank restructuring. Later, as recession deepened and social costs escalated, fiscal policies were relaxed.

  • Third, large official financing packages were seen as an essential complement to the macroeconomic and structural policies adopted to help break the self-reinforcing cycle of capital outflows, exchange rate depreciation, and financial sector weakness.

There has been criticism of IMF-supported programs in Asia, principally on three grounds; first, the appropriate focus of monetary policy as between exchange rate stabilization and the real economy; second, the stance of fiscal policy; and third, the introduction of structural reforms as part of programs. In addressing these criticisms, two points about the design of IMF-supported programs need to be borne in mind. The first is that policies adopted in response to each stage of the crisis must be seen in the context of the options available in the circumstances. By the time the Fund was called in to help design stabilization and adjustment programs in the three countries most severely affected, the immediate priority was to restore shattered investor confidence. The second point is that policy responses were adapted rapidly to changing circumstances after the onset of the crisis.

3.  Macroeconomic effects - an overview

The countries at the heart of the crisis have suffered deep recessions in 1998, although by year-end signs were emerging that the worst was over. Real GDP is estimated to have declined in 1998 by 7 percent in Korea, 8 percent in Thailand, and 15 percent in Indonesia (Table 1). Only in the Philippines was output contraction avoided. The slowdown was dramatically different from that assumed in formulating the programs, and its magnitude, once appreciated, prompted substantial revisions in economic policies.

Associated with the downturn and capital outflows were large current account adjustments which far exceeded original program projections. Current account balances strengthened by 5 percentage points of GDP in Indonesia, 15 percentage points in Korea, 6 percentage points in the Philippines, and 13 percentage points in Thailand relative to 1997, largely due to a sharp compression of imports. The response of exports was constrained by weak demand throughout the region, falling export prices, and simultaneous depreciations in partner countries. There was an even sharper decline in domestic demand, which was largely a reflection of a precipitous drop in fixed investment and, to a lesser extent, in private consumption.

4.  Macroeconomic policies

Monetary and exchange rate policies. Monetary policy in the programs sought to tread a narrow path between preventing a spiral of depreciation and inflation on the one hand, and avoiding a severe liquidity squeeze that could excessively weaken economic activity on the other. At the very start of the crisis, the currencies depreciated sharply, and, in view of the countries' large unhedged external debt, they were concerned about the further damage that would be caused by an even steeper slide in currency values. Although the key decision was made to allow exchange rates to continue to float, interest rates were raised sharply to restore some stability to foreign exchange markets. This, together with inflows of official financing, limited the extent of further depreciation. Once the currencies began to strengthen, interest rates were reduced, and by the summer of 1998 they had returned to pre-crisis levels in Korea and Thailand, and were on a downward trend in Indonesia.

A tight monetary policy was appropriate and inevitable at the outset of the programs to support an early return to external balance, and to contain and then reverse excessive currency depreciation. Given the prevalence of foreign currency-denominated debt, the alternative of permitting sharper currency depreciation through an easing of monetary policy could have had an even stronger contractionary effect. Experience with these programs has underscored the need, to which the Fund assigns high priority, to examine the role of monetary policy in the context of a financial crisis in countries with weak banking systems.

Fiscal policy. The initial programs planned some fiscal adjustment to offset a weakening of fiscal positions, to make room for financing the costs of bank restructuring and to support external adjustment (mainly in Thailand). Credible steps toward these objectives were also expected to contribute to restoring confidence.

In early 1998, as the recession deepened and current accounts shifted into large surplus owing to sagging domestic demand and large currency depreciations, fiscal policy was oriented toward supporting economic activity. Program reviews encouraged some enlargement of fiscal deficits to accommodate part of the effects of greater social spending and the exchange-rate depreciation. Programs turned progressively more expansionary, with the end result that fiscal deficits have been allowed to increase considerably. In practice, it proved difficult for the countries to use fully the scope afforded them for more expansionary budget policies, in part because of the time needed to develop effective new social spending programs.

5.  Structural reforms

The programs in the Asian crisis countries stand out by the large number and broad range of structural reforms they included. These reforms were intended to address the underlying causes of the crisis, which were predominantly structural, and to create the basis for a return to sustainable growth. Close collaboration among the World Bank, the Asian Development Bank, and the IMF were an essential feature in developing the structural components of the programs.

Financial sector and corporate restructuring. Given the role financial sector weaknesses played in the emergence of the crisis, financial sector restructuring was, from the outset, at the top of the structural reform agenda. The strategy included two broad strands of measures: first, steps were needed to handle the immediate crisis, and second, economies had to be reformed to minimize the likelihood of recurrence. Measures were introduced to deal with insolvent financial institutions, strengthen the capital base of weak but viable institutions, and address the twin risks of bank runs and excessive liquidity expansion. An overhaul of prudential regulations and supervision was initiated together with steps to enhance transparency and governance in the financial system. The restructuring of the highly indebted corporate sector began to be considered in earnest only some months after the programs were launched, and these are expected to be central issues in the second and subsequent years of the reform programs.

Other structural policies. The programs also included a large number of measures to address deficiencies in governance and market discipline, ranging from steps to enhance transparency and disclosure requirements to the dismantling of restrictive trading arrangements and privatization. In addition, steps were taken to advance trade and capital account liberalization in order to eliminate the distortions that had emerged as a result of incomplete and poorly sequenced previous reforms. In general, these measures were aimed at removing the structural weaknesses that accounted for the vulnerabilities in the financial and corporate sectors, thereby creating an environment for the resumption of sustainable growth.

6.  Social policies

The social dimensions of the programs were recognized from the start, but as the recession deepened, it became evident that the social consequences would be much greater than expected. In response, stronger measures were taken to limit unemployment, to raise income transfers, and to broaden the coverage of social safety nets which were often rudimentary. A main reason that fiscal policy was relaxed so much was to accommodate the increasing social expenditure within the programs.

The programs include many measures to strengthen social protection, and in particular to shelter the poor from the adverse effects of the economic crisis. The challenge has been to establish cost-effective, sustainable social programs that do not create large labor market disincentives or discourage job creation.

  • In Indonesia, the revised 1998/99 budget provides for subsidies on food, fuel, electricity, medicine, and other essential items to increase to 6 percent of GDP from 1/2 percent of GDP in 1997. In addition, employment-generating public works directed toward poor households, programs for children in poor regions, and credit programs targeted to rural areas and small- and medium-sized enterprises have been expanded. A targeted scheme provides a monthly ration of 20 kgs. of rice at heavily subsidized prices to poor households.

  • In Korea, unemployment insurance coverage is being extended, in several stages, to workers in small firms, as well as to part-time and temporary workers. The allocations for social assistance and special loan programs for the unemployed have been increased, a temporary program of noncontributory income support for the unemployed has been introduced, and public works programs are being expanded significantly. The cost of these programs will exceed 2 percent of GDP in 1998.

  • In Thailand, temporary labor-intensive civil works programs in construction and infrastructure rehabilitation and job training programs have been introduced, social spending has been strengthened—including an expanded coverage of benefits—and educational loan programs have been increased. Subsidies for urban bus and rail fares have been maintained.

7. Official financing and the role of the private sector

The size and openness of the countries involved, and thus the potential volume of capital outflows, meant that the amount of financing provided to support the programs had little precedent. In addition to the IMF, multilateral support was provided by the World Bank and the AsDB. Bilateral support was part of the Thailand package, while for Korea and Indonesia, a "second line of defense" was pledged by bilateral creditors, but has remained unused.

The issues that arise with the involvement of the private sector in the resolution of crisis are among the thorniest that are being addressed in the continuing discussions of the new financial architecture. The approach to involving the private sector in the Asia programs was not uniform and, initially, quite limited in part because of concerns of an adverse impact on private sector flows to other countries. As time passed, it became evident that official flows would not be enough. Mechanisms were developed to undertake rescheduling or restructuring of private sector liabilities, to restore conditions for rolling over maturing lines of credit, and securing new finance. The following notes mention briefly selected developments relating to restructuring obligations to foreign private creditors, as well as domestic debt workouts.

  • Thailand received some assurances and indications, prior to the start of its program, regarding maintenance of credit lines from foreign banks resident in the country. Moreover, to accelerate domestic debt restructuring, a year later a new framework for voluntary corporate debt restructuring, based on the "London approach," was officially endorsed by creditors.

  • Korea brought about an effective standstill on bank debt in late December 1997, and reached an agreement on rescheduling with 134 bank creditors in March 1998, after the program was in place. This enabled the rollover rate on external debt to rise from about 30-35 percent in December 1997 to 95 percent three months later. Its domestic corporate debt is being worked out under voluntary restructuring agreements among creditor banks and corporations. This process was at an advanced stage by the end of 1998.

  • Indonesia's private sector debt differed from most, in that an unusually large proportion of the debt was owed by corporations rather than having been intermediated through banks. Its resolution has been correspondingly more complex, and it was not until June 1998 that a framework agreement was reached with private creditors for restructuring interbank and corporate debt, also aimed at restoring normal trade credit. The "Jakarta Initiative" has also recognized that corporate debt workouts need to involve domestic as well as foreign creditors, and in late 1998 the Government announced a comprehensive framework to this end.

IV.  Prospects

Across Asia, the concern almost everywhere is to ensure that a new momentum is established for growth. The precise macroeconomic policies that are appropriate differ somewhat from country to country. There is greater uniformity in the need for decisive structural reform throughout the region. Despite different political systems, virtually every country faces an array of structural, institutional, and legal challenges that are strikingly similar. In part this reflects innate weaknesses in many countries. But each country in Asia, indeed around the world, currently faces the challenge of ensuring that its economic institutions keep pace with the demands of the globalized economy.

1.  Asian countries implementing IMF-supported programs

Reviews of the programs with Indonesia, Korea, and Thailand were completed by the IMF's Executive Board in mid-December; it emerged that each program was on track, and each country made purchases on schedule. A review of the Philippines program was also completed earlier in the fourth quarter. Major progress was noted in stabilizing key financial variables, but concern was expressed at the depth of recession that the countries had experienced. While an upturn in production may still be some months away, at this juncture the prospects are favorable for a return of growth during the course of 1999. In order to ensure that this recovery takes hold, and develops into a new period of sustainable growth, it is essential to press ahead with the structural reforms that have been initiated and are beginning to take effect. It is encouraging that the ASEAN's Hanoi Plan of Action (December 1998) continues to emphasize the importance of structural reform, more liberal trade, and open capital flows. In this forum of Asian and European countries, it is appropriate to highlight ASEAN's call for action by other constituencies in the global economy to do their part in strengthening national and international financial systems.

Although the contraction in Korea in 1998 was severe, the pace of decline in economic activity has now moderated. In view of the sharp economic downturn, macroeconomic policies were eased in an effort to support a recovery. Interest rates have been reduced to well below pre-crisis levels, although bank lending rates have been slower to adjust. Some scope exists for further gradual easing. After near balance in 1997, the budget deficit is targeted at 5 percent of GDP both in 1998 and 1999. Assuming progress on financial and corporate restructuring, and a more favorable external environment, the economy is expected to begin a recovery. Korea's progress is amply demonstrated by the authorities' capacity to begin prompt repayment of its obligations to the IMF. It may be recalled that Korea was the first country to use the Supplemental Reserve Facility, under which repayments begin to fall due within one year. Its action sends out a clear signal of the recovery that is under way.

Over the medium term, the Korean economy is expected to resume a high growth path, albeit at lower rates than it had enjoyed in the past two decades. While strong savings and improved productivity will play a key role in returning Korea to sustainable growth, the deep structural problems affecting the economy will take several years to resolve. Financial and corporate restructuring remain at the heart of the Fund-supported program, and reform is most advanced in the financial sector where significant steps have been taken toward rationalizing and recapitalizing the financial sector. Corporate reform is under way, but much remains to be done especially with regard to restructuring the top five chaebols. Initially, these chaebols had not been included in the debt workout process and had made limited progress in restructuring, but a recent agreement among the top chaebols, creditors, and the government has been announced. The pace of restructuring will need to be accelerated further over the coming months.

In Thailand, a number of indicators point to an easing of the recession. Key financial indicators are encouraging: inflation has stayed lower than expected, the baht has appreciated, money-market interest rates have fallen below pre-crisis levels, and equity prices are now well above their lows. The very large swing (equivalent to 13½ percent of GDP) in the external current account balance is reflected in the level of gross official reserves, which provided over 8 months of import coverage by the end of 1998. The decline of manufacturing output has slowed sharply, and finance and business expectations are notably less pessimistic.

Current projections anticipate modest positive growth of about 1 percent for 1999 as a whole. For the near term, in order to promote recovery, fiscal policy will remain expansionary, with a deficit of 5 percent of GDP in prospect (8 percent, including financial restructuring costs.) The prospects for a more rapid recovery are muted by the continuing fragility in the financial and corporate sectors, where the reforms and restructuring are still incomplete, although important reforms were initiated in August. If these reforms are carried through, then the prospects are good for an eventual return to a sustainable growth path at quite high rates, though falling short of the pace seen in the pre-crisis years.

Indonesia, where both economic and social instability have been the greatest, is also showing signs that the worst may be over, although social and political stability will be needed to allow a full recovery of confidence. As in Korea and Thailand, the financial indicators have been the first to respond: interest rates are declining, the currency is appreciating, and usable international reserves had risen to the equivalent of 5 to 6 months of imports by the end of 1998.

A modest recovery of output is now projected to begin during the second half of 1999. Over the next year, end-period inflation is expected to drop sharply from its current level of 80 percent to just 10 percent. With some stabilization gains already evident, a judicious use of macroeconomic policies is possible to provide some stimulus to the economy. The program agreed with the authorities encourages accelerated development expenditures by allowing a fiscal deficit of 6 percent of GDP for 1999/2000, and foresees room for a careful easing of monetary policy to help economic recovery. For the medium-term strength of the economy, among the key structural issues is the need to move ahead quickly with bank recapitalization, and improved bank supervision and regulation. Restoring viability to the corporate sector is essential, to which end the Jakarta Initiative, the framework for corporate debt workouts, needs to be made operational by taking the necessary legal, regulatory and personnel actions.

In the Philippines, less severely affected than the countries in crisis, growth prospects are moderately positive: after slightly positive growth in 1998, the prospects are for 2-3 percent growth this year. Macroeconomic policies were reoriented to support domestic demand by an expansionary fiscal policy that is continuing into 1999, and the cautious easing of monetary policy that is under way. The external current account swung into small surplus in 1998, but one of the policy challenges for the coming year will be to raise external reserves.

Prospects for the medium-term have been bolstered by a structural reform program that has been broadened to include, in addition to banking and tax administration, the corporate and public sectors, as well as extending the process of trade liberalization that has been under way for several years. Even though the Philippines has not suffered as deep a banking or corporate sector crisis as elsewhere, it is taking measures to strengthen banks' capacity to withstand shocks, and to enhance prudential and supervisory structures.

2.  Other Asian countries

Japan, as the world's second largest industrial economy, has a key role to play in both regional and global terms. Recent policy actions and developments are welcome, but may not be sufficient to turn the economy around before next year. Although rising public investment may have arrested the output decline in the fourth quarter of 1998, indicators of private domestic demand remain weak. A prerequisite to re-igniting sustained economic growth is the resolution of the problems in the banking system, and the October legislation represents a significant step in this direction. The critical challenge for the authorities is to catalyze a quick and forceful recapitalization and restructuring that will restore the financial health and profitability of the banking system, including a full and transparent accounting of banks' financial positions to restore investor confidence. In addition, further progress with deregulation and broader structural reform is essential for the economy to regain its dynamism and meet the needs of its aging population. But macroeconomic policies also have a major role to play in stimulating domestic demand—a role that is facilitated by the absence of inflation and the large external current account surplus.

The scope to reduce interest rates further has been very limited since the Bank of Japan lowered its operating target for the overnight call rate to 1/4 percent in early September. The Bank of Japan has appropriately continued to boost liquidity growth and support private sector credit creation through operations in the private debt market. These operations can continue to play a useful role in helping to moderate deflationary pressures.

While Japan clearly faces a difficult challenge of fiscal consolidation in the medium term, in the short term the paramount need is to ensure a resumption of growth. The initiatives it has taken recently and the renewed determination it is showing are welcome developments, clearly moves in the right direction. The package of fiscal measures introduced in mid-November 1998, and tax cuts and higher public spending in the FY 1999 budget promise significant stimulus in 1999, magnifying the effects of the April package that are already beginning to be felt. The critical challenge at this point will be to ensure that these recent commitments are implemented in a manner that quickly provides the needed stimulus to domestic demand.

In China and Hong Kong SAR, the successful maintenance of the exchange rate regimes has helped restore stability in Asian financial markets. China's ability to float an international bond that was heavily oversubscribed and at an impressively low spread in current conditions, is testament not only to China's strength, but also to a gradual return of confidence in Asia as a whole. Currency pressures had already eased considerably in recent months in both China and Hong Kong, partly owing to the weakening of the U.S. dollar relative to other major currencies. This has facilitated a lowering of interest rates in both cases. Fiscal policy is also providing helpful support to demand in both cases. While fiscal stimulus in China is appropriate, its composition should be carefully tailored to ensure that spending is efficient and the quality of growth is not compromised. Interest rate policy will need to remain cautious in light of continuing outflows on the capital account of the balance of payments. In this context, it will be important for the recent intensification of capital controls to be implemented without adversely affecting legitimate trade and investment activities. The recent problems in some financial institutions underscore the need for continued financial sector reform.

India's situation is rather different from those in East Asia. It has experienced a mild slowdown, while inflation has risen reflecting agricultural supply difficulties, rapid monetary growth, and currency depreciation. The current account position has weakened, but international reserves remain comfortable. The first priority is to address weakness in the fiscal position and to place the budget deficit firmly on a downward path. Efforts to rein in the rapid rate of monetary expansion are required to contain inflationary pressure. Aside from these macroeconomic policy requirements, a wide range of structural reforms are needed to boost confidence and reinvigorate growth.

In Malaysia, economic activity remains weak, and the prospects for sustained medium-term recovery are more uncertain than the other East Asian countries in crisis. The IMF's forecasts of an 8 percent decline in GDP in 1998 and 2 percent decline in 1999 indicate that the policy stimulus of July 1998 has yet to take effect. Policy is becoming more expansionary, as elsewhere in the crisis countries, through the larger fiscal deficit planned for 1999 and through an easing in monetary policy. At the same time, some steps were taken to strengthen the financial and corporate sectors. However the effect of these measures on medium-term growth prospects was jeopardized by the imposition of capital and exchange controls and by the relaxation of some prudential standards and introduction of directed lending. While capital outflows have been stemmed and external reserves have risen, investor confidence has been damaged by the capital controls, and some official sources of external finance have dried up. Neither source is likely to recover until the overall stance of policies is modified.

V.  Characteristics of a revitalized Asia

This section sketches some of the features that should characterize Asia as it emerges from the crisis. Many of these features are policies that may need to be adopted by governments, and each may be regarded as a necessary condition for the resumption of sustainable high-quality growth, but in each case, the individual policies are not sufficient to ensure the desired outcome. The key, therefore, is sustained implementation of policies across a very wide front, so that Asia may eventually regain its position at the forefront of international development.

Few analysts doubt that the Asian countries in crisis have the potential to return to rapid growth paths, although the rates of growth may be slightly lower than witnessed in the pre-crisis years. Even if the volume of investment is less than in the past, the determined implementation of structural reforms will contribute to growth through gains in efficiency. To achieve lasting growth, action on many fronts is needed. These may be conveniently divided among policies that enhance the features that have traditionally been analyzed as at the heart of East Asia's remarkable progress, and those that need to be given a higher profile in policy formulation.

1.  Enhancing "traditional features"

An Asia that is open and competitive. It is impressive that, despite the severity of the recession, most countries in the region have eschewed protectionist policies. They have recognized, correctly, that the strong growth of the past had benefited from the progress toward open trade, investment, and payments regimes. This necessary, if not sufficient, condition for ensuring the growth of internationally competitive industries will need to remain at the heart of economic thinking.

An Asia with sound macroeconomic policies. The sound policy stance, which was perceived to be one of the hallmarks of the high-growth era in Asia, will need to be reinforced with robust institutions and market-based policy instruments. An instinctive preference for conservative financial policies has meant that it did not come easily for some countries deliberately to relax their policies to provide the necessary stimulus for economic growth. This attitude augurs well for the continuation of sound financial policies when the recovery begins.

An Asia that saves judiciously. The high rates of domestic saving that were observed in the past were important to financing development. As recovery resumes, it will be essential to ensure that the macroeconomic conditions and institutional requirements conducive to continued strong saving are continued.

An Asia that invests efficiently. Even if high savings rates continue, it is likely that the foreign resources available will be more constrained and more expensive than in the past, as foreign investors' risk aversion has clearly increased as a result of the crisis. Thus while high investment ratios will clearly be desirable, it is most important that efficiency gains be promoted through a competitive environment and the promotion of a culture of seeking technical progress.

2.  Policies for higher quality growth

An Asia with sound financial systems. Weak financial systems have been identified as one of the central flaws in the East Asian "model." A good start has been made in reform of financial sectors, but the process is inevitably time-consuming. The authorities throughout the region—not just the immediate crisis countries—need to give the highest priority to ensuring the establishment of robust financial systems with sound regulatory and supervisory structures and, where necessary, undertaking the closure, restructuring, or recapitalization of troubled banks. The construction of sound national banking systems, according to the Basle Core Principles, will contribute a more robust international system.

An Asia that promotes an independent, competitive private sector. Weak corporate governance has been identified as another central flaw in Asian economies and must be addressed for long-term economic viability. In the near term, since many corporations are suffering intense liquidity or solvency strains, a priority is to press ahead with corporate debt work-outs to establish viable corporations on a sound financial footing. At the same time, governments need to press ahead with strategies to bolster the private sector, through phasing out direct state ownership, encouraging foreign enterprises and banks, establishing clear legal frameworks that promote competition and expose companies to bankruptcy, and introducing internationally accepted norms of accounting and auditing.

An Asia with high standards of public sector governance and transparency. A crucial principle that will be needed to ensure sound public and corporate governance is that an "arm's length" relationship be maintained between the government and corporate sectors. The public sector also needs to operate to the highest standards of data dissemination to ensure that comprehensive, accurate, and timely information is available, and to begin to observe the code on transparency in fiscal policies recently established by the IMF. In due course, we would call on these countries—as indeed, all countries around the world—to adopt similar standards with respect to monetary and financial polices.

An Asia with open capital markets. It is entirely appropriate that, in support of the other policies they are pursuing, countries throughout Asia should continue with strategies, tailored to their individual situations, to liberalize their capital accounts. But they should do so under two broad conditions: first, liberalization should proceed in a properly sequenced fashion with the strengthening of their domestic financial systems. Second, they should take care to avoid a process in which the easing of controls on longer term flows, especially of direct investment, lags behind de facto liberalization of short-term flows. It will be essential that these national measures are supplemented by a convincing international effort to introduce prudential measures for cross-border transactions.

An Asia that enhances social welfare and environmental protection. The severe recession in Asia has imposed a heavy burden on the populations of the affected countries, and many have descended into poverty. The lasting solution is to stimulate durable economic growth that will generate jobs and raise incomes. At the same time, governments' policies and spending priorities should recognize the special needs of disadvantaged parts of the population and make adequate provisions for strong education and health systems. The current crisis has revealed that these countries had tended to rely on the protection provided by the extended family, and had only rudimentary social security systems. The steps initiated under the programs in the past year will need to be strengthened. In the same vein, as growth resumes, so the pressures on the environment will intensify, adding to an already serious problem. Countries will need to develop a new path that will involve different combinations of incentives, regulations, and institutional changes. Support from the World Bank is available to this end.

* * * * *

In sum, recent developments in Asia give further encouragement to the view that eventually the countries in crisis can return to high growth rates that can be reflected across the region. At present, it is possible to identify risks and constraints, particularly with regard to the external environment and the return of new capital inflows to the region, that make the precise pace and timing of the recovery a little uncertain. But our view—one that now seems to be shared by many outside the IMF—is that recovery will be under way by the end of 1999.

1World Economic Outlook and International Capital Markets-Interim Assessment (Washington: International Monetary Fund, December 1998).
2This section draws upon the forthcoming IMF study entitled "IMF-supported Programs in Indonesia, Korea, and Thailand: A Preliminary Assessment," which provides a detailed analysis and assessment of these programs, reviewing their background, design, and implementation.

Table 1.  Selected Asian Countries: Key Economic Indicators, 1990-991

1996 1997 1998

Real GDP (percent change)




- 7.0

- 1.0





- 15.3

- 3.4





- 7.5

- 2.0










-0.4 -8.0 1.0
Real total domestic demand (percent change)
   Korea 8.5 8.2 -2.8 -23.9 ...
   Indonesia 9.3 8.6 6.8 -20.4 ...
   Malaysia 11.6 5.3 7.2 -24.0 ...
   Philippines 3.6 7.0 6.6 -15.5 ...
   Thailand 10.1 6.2 -7.6 -21.9 ...
Real exports (percent change)
   Korea 13.1 13.0 23.6 12.2 ...
   Indonesia 10.0 5.5 10.2 -9.4 ...
   Malaysia 15.7 7.2 8.8 -4.2 ...
   Philippines 8.2 20.3 17.6 16.9 ...
   Thailand 14.2 -1.8 6.6 4.6 ...
Real imports (percent change)
   Korea 14.8 14.8 3.8 -20.8 ...
   Indonesia 15.5 7.8 17.2 -26.6 ...
   Malaysia 19.3 4.2 8.3 -19.8 ...
   Philippines 9.9 21.1 14.4 -12.6 ...
   Thailand 15.4 -0.9 -10.0 -25.0 ...
Inflation (CPI) (percent change)
   Korea 6.6 4.9 4.4 7.8 3.8
   Indonesia 8.7 7.9 6.6 61.1 26.8
   Malaysia 3.5 3.5 2.7 5.2 5.8
   Philippines 10.9 8.4 6.0 9.8 8.8
   Thailand 5.0 5.9 5.6 8.0 2.5
Government balance (in percent of GDP)3
   Korea -0.3 0.3 0.3 -5.0 ...
   Indonesia 0.0 1.2 0.1 ... ...
   Malaysia -0.4 5.0 6.0 -2.6 ...
   Philippines -1.9 -0.4 -1.0 -2.7 ...
   Thailand4 ... 2.8 -2.7 -5.9 ...
Current account (in percent of GDP)
   Korea -1.2 -4.7 -1.8 13.3 8.7
   Indonesia -2.5 -3.3 -1.8 3.0 2.0
   Malaysia -6.2 -4.9 -4.2 11.0 9.2
   Philippines -4.1 -4.7 -5.2 1.2 0.6
   Thailand -6.6 -7.9 -2.0 11.4 8.4
Total external debt (in billions of U.S. dollars)
   Korea ... 160.7 154.4 147.9 ...
   Indonesia 86.7 130.2 137.9 ... ...
   Malaysia 24.1 38.7 43.4 39.6 ...
   Philippines5 32.9 41.9 51.7 45.8 ...
   Thailand 51.7 90.5 93.4 85.4 ...
Total external debt, short-term (in billions of U.S. dollars)
   Korea ... 100.0 68.4 35.3 ...
   Indonesia 8.1 28.0 ... ... ...
   Malaysia 4.6 9 .7 10.7 7 .0 ...
   Philippines 5.0 7.2 9.0 ... ...
   Thailand 22.9 37.6 34.8 25.0 ...
Reserves (in billions of U.S. dollars) - end of period
   Korea: usable reserves ... 29.4 9.1 48.5 ...
   Indonesia: gross reserves ... ... 21.5 23.8 ...
   Malaysia ... 27.0 21.7 26.2 ...
   Philippines: gross reserves (quarterly)6 ... 10.4 7.7 9.4 ...
   Thailand: gross reserves ... 38.7 27.0 29.5 ...

1All data are on a calendar year basis, except as indicated.
2Data for 1998 and 1999 are based on staff estimates for the December 1998 Interim World Economic Outlook.
3General government balance including the interest costs of financial sector restructuring. Cross-country comparisons are not strictly accurate because of differences in definition.
4Data is on a fiscal year basis.
5Data for 1998 are for June 1998.
6Data for 1998 are for end-September.


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