The Financial Crisis in Emerging Markets: Lessons for Eastern Europe and Asia -- Stanley Fischer

IMF News, April 23, 1999

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Published: April 23, 1999

Overview and context

Outline of comments prepared for delivery at the EastWest Institute conference, New York, April 23, 1999.
Early signs by then of recovery:
- Thai devaluation in July 1997 marked the start of the global financial crisis.
- Activity appeared to have turned around in Korea and bottomed out in Thailand.
- Brazil raised $2 billion from the markets amid a revival of confidence since early March.
- Negotiations between Russia and the IMF were making some progress.

I. The Crisis — key observations

Surprise element:
- Countries with longstanding exemplary policies and performance (outward-oriented policies, high rates of saving and investment, investments in human capital, governments oriented to economic development, and prudent macroeconomic policies) nevertheless entered deep crises.
Sequence and contagion:
- Asian crisis followed by pressures on Russia’s financial markets, exacerbated by declining oil and commodity prices and the Russian devaluation and unilateral debt restructuring of August 1998.
- From Russia, contagion spread to Latin America and to financial markets of the United States, raising fears at the October Annual Meetings of IMF and World Bank of possibly the worst post-World War II financial crisis.
- Good economic management, especially by the Fed, helped avert the worst outcomes.

II. Some early lessons — findings and implications

Globalization and policy choice
- Lesson: "globalization is here to stay" — openness, integration, and structural reforms were generally maintained by emerging market policymakers during the crisis.
- Example quote: Last September, the Finance Minister of Argentina: "Crises come, and eventually they go. Our success after the crisis will be determined by how we behave during the crisis. We must maintain our policies if we want to continue to be successful."
Domestic policy and financial system strength
- Finding: The strength of the financial system is critical; financial sector weakness and poor corporate governance were major factors in the Asian crisis.
- Brazil shows crises can happen even when financial systems are relatively strong, but extent depends on system strength.
Structural reform and transition economies
- Finding: Structural reform matters greatly; Russia’s persistent large fiscal deficits reflected insufficient reform and industrial restructuring.
- Observation: "moving fast generally works" — transition economies that moved fastest and most persistently on structural reforms have fared best over the past 10 years.
- Korean case: Benefits of moving very fast to correct structural imbalances in financial and corporate sectors.
Fiscal policy and gradualism
- Russia as example of cost of gradualism on the fiscal front: failure to bring budget deficit under control increased vulnerability and unsustainable debt dynamics leading to August 1998 crisis.
Exchange rate systems
- Finding: Crises in Thailand, Indonesia, Korea, Russia, and Brazil were associated with exchange rates that had been more or less fixed, suggesting such systems are crisis-prone.
- Counterexamples: Mexico, Turkey, and South Africa managed pressures better with flexible exchange rates.
- Likely implication: More countries will adopt flexible exchange rate systems or, if fixing, do so definitively (for example by adopting a currency board arrangement).
Ownership of reforms
- Finding: "Ownership" of economic programs—broad political consensus and government commitment—greatly increases chances of successful reform.
- External assistance is difficult where governments are weak and political consensus absent; beyond some point, continued support may be unwise.

III. Improving the international financial system — reforms, tools, and principles

Contingent Credit Lines (CCL)
- IMF Executive Board discussed establishing a CCL to allow countries to put in place contingent IMF credit lines activated in the event of contagion.
- CCL intended to encourage preventive support and create incentives for countries to strengthen their economies to deal with potential crises.
- Status at time of remarks: many technical problems solved, "final agreement is likely very soon."
Development and adoption of international standards
- IMF’s Special Data Dissemination Standard established after the Mexican crisis and operational; "Nearly fifty countries, both industrial and emerging market, have subscribed."
- IMF standards for fiscal transparency, and for monetary and financial policy transparency, are being put into operation.
- Basle Committee core banking standards developed in 1997 set standards for bank management and supervision.
- Other codes prepared or in preparation: social safety networks, corporate governance, accounting, insurance, and securities markets.
- Key point: Adoption by countries (including some industrialized countries that do not meet them) is far more important than development.
- Incentives: One condition for CCL access is progress in attempting to meet the standards; regulators in industrialized countries could condition risk weightings on exposures to the extent countries meet standards.
- Private sector response is decisive: if borrowing terms depend on meeting standards, countries will be encouraged to adopt them.
Financial Stability Forum
- Newly established forum bringing together the G-7, international financial agencies, and international regulatory agencies (including Basle Committee, IOSCO, and bodies for accounting and insurance regulation).
- First meeting held the week before these remarks in Washington; mandate to meet regularly and address major international financial system issues such as the role of highly levered institutions.
Private sector involvement in prevention, mitigation, and resolution
- Progress beginning but complex and sensitive; no single formula.
- Prevention: suggestions for changes in contract forms, including bond contracts, under discussion.
- Post-crisis approaches included the voluntary agreement by foreign creditor banks to maintain trade and interbank lines to Brazil and a different approach in Ukraine.
- Guiding principles:
- Contracts must wherever possible be honored.
- Debtor countries need to cooperate with creditors.
- Official sector financing may not always be sufficient; private sector contributions may be necessary and should be discussed between country and creditors depending on circumstances.

Policy recommendations and forward agenda (implicit in remarks)

Maintain openness and engagement in global capital markets while strengthening domestic financial systems and governance.
Pursue rapid and persistent structural reform, particularly during and after crises, to restore sustainable growth.
Favor flexible exchange rate regimes or definitive fixing arrangements to reduce crisis vulnerability.
Ensure national ownership of reform programs to increase likelihood of success; calibrate external assistance where political commitment is weak.
Complete and implement international reforms:
- Finalize and operationalize Contingent Credit Lines (CCL).
- Promote adoption and monitoring of international standards (data dissemination, fiscal/monetary/financial transparency, core banking standards, corporate governance, accounting, insurance, securities markets).
- Leverage the Financial Stability Forum to coordinate regulatory responses and address systemic issues such as highly levered institutions.
- Develop practical frameworks for appropriate private sector involvement in crisis prevention and resolution, while upholding principles that support private capital markets.

Comments by Stanley Fischer, First Deputy Managing Director of the International Monetary Fund, at the EastWest Institute, New York, April 23, 1999. The views expressed are those of the author, and are not necessarily those of the IMF.