The Asian Crisis, the IMF, and the Japanese Economy

IMF News, April 8, 1998

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• Published: April 8, 1998

I. The IMF and the Asian crisis

• Context and common problems across Thailand, Indonesia, and Korea:
  • Loss of market confidence, deep currency depreciation, weak financial systems, and excessive unhedged foreign borrowing by the domestic private sector.
  • Lack of transparency about ties between government, business, and banks.
  • Differences in initial sizes of current account deficits and stages of crises when IMF support was requested.
• IMF program design and controversies:
  • Two main regional criticisms: (1) programs are "the same old IMF austerity medicine" and (2) programs go beyond macrobalance to mandate financial restructuring and corporate governance improvements.
• Monetary policy rationale:
  • Priority: restore confidence in the currency by making it more attractive to hold domestic currency; requires temporarily increasing interest rates even if that complicates weak banks and corporations.
  • Lesson drawn from prior crises (tequila 1994-95, Brazil, Czech Republic, Hong Kong, Russia): timely and forceful tightening of interest rates can fend off attacks on currencies.
  • Argument against lower interest rates and larger devaluations: steep domestic currency slides harm companies with substantial foreign currency debts more than temporary higher domestic interest rates; delayed interest rate action perpetuates loss of confidence.
  • Devaluations are excessive from both individual country and international system perspectives; risk of large current account surpluses in crisis countries damaging competitors.
• Fiscal policy approach and figures:
  • Fiscal tightening aimed to make room for future financial restructuring costs and, depending on balance of payments, to reduce current account deficits.
  • Treatment of financial sector cleanup costs: programs include expected interest costs, not capital costs.
  • Example: if cost of cleaning up the financial sector is expected to amount to 15 percent of GDP, the corresponding fiscal adjustment would be about 1.5 percent of GDP.
  • Initial fiscal adjustments: Indonesia 1 percent of GDP; Korea 1.5 percent of GDP; Thailand 3 percent of GDP (reflecting a current account deficit of about 8 percent of GDP).
  • Automatic stabilizers allowed to operate if economic situation weakens; fiscal deficit level cannot be a matter of indifference given limited borrowing access and risks of money printing.
• Structural policies and justification:
  • Core of programs: financial sector restructuring and broader structural reforms to address weak financial institutions, inadequate bank regulation and supervision, and non-transparent government–bank–corporate relations.
  • IMF stance: recapitalize or close insolvent banks, protect small depositors, require shareholders to take losses, and improve banking regulation and supervision.
  • Structural measures included when essential to restoring economic health; long-term structural implementation often involves World Bank and ADB support.
  • Response to Martin Feldstein’s three proposed tests:
  • Restoring access to international capital markets: yes in Asian programs.
  • Technical nature of measures and sovereignty concerns: banking reform is technical; trade liberalization likewise part of Fund and World Bank programs.
  • Would similar measures be requested of major industrial economies under Fund programs: yes.
  • Fundamental test emphasized by IMF: does the program address underlying causes of the crisis?

II. Prospects for the crisis countries

• Recent financial turnaround indicators (since start of the year):
  • The baht and the won have each strengthened by about 18 percent; they are now worth about 38 percent less in terms of dollars than they were in June 1997.
  • Korean and Thai stock markets are up about 20 percent since the start of the year.
  • Currencies of Malaysia and the Philippines are up about 4 percent this year, down about 30 percent since the middle of last year; their stock markets are higher than at the turn of the year but well down from the middle of last year.
• Indonesia exceptional case:
  • Indonesian currency has lost 70 percent of its value since the middle of last year, and about 35 percent of its value since the beginning of this year.
  • Nearing an agreement with the IMF that, if rigorously adhered to, will strengthen the rupiah and financial stability and implement structural reforms including in the financial sector.
• Recovery dynamics and risks:
  • Restoration of confidence is gradual and must be earned through actions not promises.
  • Internal risks: failure to follow through on politically difficult reforms due to complacency, inability to overcome vested interests, or loss of political will.
  • External risks: adverse external environment; concern about Chinese and Japanese economies (possibility of Chinese devaluation; slow growth and deteriorating Japanese banking sector).
  • IMF assessment of China: Chinese authorities determined not to devalue; that stance is commended and reduces the risk of regional renewed devaluations.

III. The Japanese economy

• Overview of Japan’s situation:
  • After forty years of outstanding performance, Japan has virtually stagnated in this decade.
  • Recent signals (tankan survey, public comments including by Governor Hayami) reinforce urgency to act.
• Fiscal policy recommendations:
  • Immediate need for a substantial fiscal expansion.
  • Suggested package: 16 trillion yen, about 3 percent of GDP, would be a good starting point; program implemented should be close to that starting point.
  • Concerns about wasteful spending: at least half of the package should take the form of tax cuts.
  • Rationale: tax measures can be effective stimulants; last year’s tax increases were effective in curbing demand.
  • Acknowledge Japan’s long-term demographic fiscal challenges, but prioritize short-term growth now.
• Financial sector and structural reforms:
  • Bad loan problem from bubble years has festered, contributing to unprecedented bank failures in late 1997, loss of confidence, and tightened credit despite record low interest rates.
  • Recovery requires prices of distressed assets to touch bottom and re-establish a liquid market.
  • Need for decisive break with past ad hoc, reactive approaches; markets favor clear, decisive strategy even with difficult initial adjustments.
  • Recent public funds injections to address banking weakness were welcome but risk delaying resolution by cushioning weak banks and undermining incentives to adjust.
  • Without a credible solution to bad debt problem, other stimulative actions will likely provide only temporary relief and risk further prolonged slowdown.
• Essential ingredients of a comprehensive and transparent banking resolution approach:
  • Early identification and prompt closure of insolvent institutions.
  • Aggressive efforts to dispose of problem loans.
  • Linking future injections of public funds to strong restructuring plans, including a requirement to raise funds from the market.
  • An end to regulatory forbearance in recognizing the extent of bad loans.
  • Adoption of international disclosure standards.
  • A large increase in resources for the new financial supervision authority, more than currently envisaged, to allow it to fulfill its mandate.
• Transparency:
  • Lack of transparency in both banking and fiscal areas has prolonged problems.
  • Difficulty in determining what is included in fiscal packages contributed to miscalculation of the impacts of the tax increase in 1997.
  • Transparency is a key lesson from the Asian crisis and applies to Japan.
• Conclusion on regional outlook:
  • Strategy followed in IMF-supported programs in Korea and Thailand is beginning to work; IMF is confident it can work in Indonesia if rigorously implemented.
  • The Asian crisis has been contained; growth in the region can resume within a reasonable period if courageous policy decisions are made by all countries in the region, including Japan.

Stanley Fischer; Tokyo, Japan, April 8, 1998. Stanley Fischer is First Deputy Managing Director of the International Monetary Fund. The views expressed are those of the author, and not necessarily of the International Monetary Fund.

References

• People's Republic of China and the IMF
• Indonesia and the IMF
• Japan and the IMF
• Republic of Korea and the IMF
• Russian Federation and the IMF
• Thailand and the IMF
• Speeches
• PRESS CENTER
• https://www.imf.org/en/home