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

_IMF News, January 22, 1998_

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## Bibliographic details
- Published: January 22, 1998

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### 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._

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## References

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