The Asian Crisis: A View from the IMF--Address by Stanley Fischer

IMF News, January 22, 1998

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Published: January 22, 1998

Asia's economic success

Annual GDP growth in the ASEAN-5 (Indonesia, Malaysia, the Philippines, Singapore, and Thailand) averaged close to 8 percent over the last decade.
During the 30 years preceding the crisis per capita income levels had increased tenfold in Korea, fivefold in Thailand, and fourfold in Malaysia.
Per capita income levels in Hong Kong and Singapore now exceed those in some industrial countries.
Until the current crisis, Asia attracted almost half of total capital inflows to developing countries--nearly $100 billion in 1996.
In the last decade, the share of developing and emerging market economies of Asia in world exports has nearly doubled to almost one fifth of the total.
These countries bought about 19 percent of U.S. exports in 1996, up from about 15 percent in 1990.

The origins of the crisis

Key domestic factors:
- Failure to dampen overheating pressures manifested in large external deficits and property and stock market bubbles.
- Maintenance of pegged exchange rate regimes for too long, encouraging external borrowing and excessive exposure to foreign exchange risk.
- Lax prudential rules and financial oversight leading to sharp deterioration in banks' loan portfolios.
Political uncertainties and doubts about authorities' commitment and ability to implement adjustment and reforms exacerbated market pressures.
External contributors:
- Weak growth in Japan and Europe, accommodative monetary policy, and low interest rates spurred large private capital flows to emerging markets, including the "carry trade."
- Wide swings of the yen/dollar exchange rate over the past three years contributed to the buildup.
Country illustrations:
- Thailand: strong growth averaging almost 10 percent per year from 1987-95, continuous public sector fiscal surpluses over the same period, exceptionally large current account deficit of 8 percent of GDP, large short-term capital inflows, and a delayed policy response leading to a currency crisis.
- Indonesia: current account at 3 1/4 percent of GDP; requested IMF assistance earlier and initially showed promising reform progress.
- Korea: current account on a downward path; came closer to catastrophe but improved following election of Kim Dae-Jung and forceful implementation of IMF-supported program.
- Philippines: decision to extend an IMF-supported program helped mitigate crisis effects.
Contagion dynamics:
- Depreciation of the baht eroded competitiveness of trade competitors, prompting downward pressure on their currencies.
- Markets reassessed neighboring countries and found similar weaknesses, particularly in the financial sector.
- Currency slides increased domestic private sector debt service costs, prompting hedging and intensifying exchange rate pressures.
- Markets have overreacted; exchange rate adjustment has far exceeded reasonable estimates required to correct initial overvaluation in affected currencies.

IMF-supported programs in Asia — design and measures

Common program elements:
- Substantial rise in interest rates to halt currency depreciation.
- Forceful, up-front action to put financial systems on a sounder footing.
- Closure of non-viable institutions; restructuring plans for others; compliance with internationally accepted best practices including the Basle capital adequacy standards and internationally accepted accounting practices and disclosure rules.
- Institutional changes to strengthen regulation and supervision, increase transparency, create a level playing field, and open markets to foreign participants.
Fiscal adjustments to cover carrying costs of financial sector restructuring and restore sustainable balance of payments:
- Thailand: initial fiscal adjustment of 3 percent of GDP.
- Korea: initial fiscal adjustment of 1 1/2 percent of GDP.
- Indonesia: initial fiscal adjustment of 1 percent of GDP, much of which will be achieved by reducing public investment in low-return projects.
Rationale for policy stances:
- Temporary sharp increase in interest rates to make holding domestic currency more attractive and restore confidence, despite short-term complications for weak banks and corporations.
- Higher interest rates incentivize corporate sector restructuring from debt toward equity.
- Fiscal tightening at the outset to address future financial restructuring costs and current account needs; allowance for automatic stabilizers and some deficit widening if the situation worsens.
- Rapid action on insolvent banks: recapitalize or close, protect small depositors, require shareholders to take losses, and strengthen regulation and supervision.
Trade-offs and expected outcomes:
- Short-term slowdown in economic activity is inevitable; without international assistance, slowdown, costs to the population, and global risks would be much greater.
- International assistance from the IMF, the World Bank, and bilateral sources is intended to limit damage to the global economy.

Moral hazard and distribution of losses

Arguments against intervention (letting “chips fall where they may”) are rejected:
- No country would deliberately court a crisis to access IMF assistance; economic, financial, social, and political pain is too great.
- Most investors have incurred substantial losses; foreign equity investors have lost nearly three-quarters of the value of their equity holdings in some Asian markets.
- Many firms and financial institutions will go bankrupt, with both foreign and domestic lenders sharing losses; international banks are sharing crisis costs and some may be forced to write down claims.
Trade-off faced:
- Allowing deeper crisis could teach lenders a lesson but would cause more bankruptcies, layoffs, recessions, and depreciations, with worse outcomes for global trade and growth.
- Mitigating the crisis through international action is preferred to preserve global economic stability and an economically strong Asia.

Role and purpose of the IMF

Primary purposes (quoted from the IMF's Articles of Agreement):
- "to facilitate...the balanced growth of international trade, and to contribute thereby to...high levels of growth and real income"--and the IMF has consistently promoted trade liberalization;
- "to promote exchange rate stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation"; and
- to provide members "with opportunities to correct maladjustments in their balance of payments, without resorting to measures destructive of national or international prosperity."
Core approach:
- Encourage sound economic policies and openness to trade and investment.
- Seek to avert crises through surveillance and warning; strengthen surveillance though not every crisis can be anticipated.
- Provide expertise, pragmatic solutions, and mobilize international resources when crises occur, sharing responsibility among the international community.
Historical roles cited:
- Recycling surpluses of oil exporters in 1973-74.
- Central role in the mid-1980s debt strategy.
- Assistance to 26 transition countries after 1989.
- Support during the 1994-95 Mexican crisis to avert broader contagion.

IMF resources and financing

Quotas:
- On joining the IMF, each member subscribes a quota; members normally pay 25 percent of their quota subscriptions out of foreign reserves, the rest in national currencies.
- The United States has over 18 percent of the shares and effectively has a veto on major Fund decisions requiring an 85 percent majority.
Recent resource augmentations:
- Fund membership agreed to increase IMF quotas by 45 percent, about $88 billion, raising the capital base to some $284 billion.
- The United States' share of this increase would be nearly $16 billion.
- New Arrangements to Borrow (NAB): participants prepared to lend up to about $45 billion when additional resources are needed to forestall or cope with an impairment of the international monetary system or to deal with an exceptional situation that poses a threat to the stability of the system.
Characterization of IMF financing:
- IMF operates like a credit union; contributions are investments on which members earn interest, and the Fund's provision of financial resources has involved little cost, if any, to creditor countries.

Policy recommendations and implications

Immediate policy priorities for crisis countries:
- Implement a sharp, temporary increase in interest rates to stem capital outflows.
- Take forceful, up-front action to restructure financial sectors: recapitalize or close insolvent banks; protect small depositors; enforce shareholder losses.
- Strengthen financial regulation and supervision to meet international standards.
- Increase transparency in corporate and government sectors and foster domestic competition and market openness.
- Implement fiscal adjustments sufficient to cover financial restructuring carrying costs and restore balance of payments; allow automatic stabilizers to operate if conditions worsen.
International response:
- Coordinate IMF, World Bank, and bilateral assistance to limit regional and global fallout.
- Mobilize additional IMF resources through quota increases and the NAB to support the international monetary system.
Expected trade-offs:
- Short-term economic slowdown and social costs versus avoiding a deeper, more destructive adjustment if international assistance is withheld.

Stanley Fischer — Address by First Deputy Managing Director of the International Monetary Fund at the Midwinter Conference of the Bankers' Association for Foreign Trade, Washington, D.C., January 22, 1998.