February 7, 1998
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Caracas, Venezuela, February 7, 1998
Against this backdrop, I assure you that I look forward to the insights and ideas that will emerge from your discussions. In hopes of contributing to this reflection and debate, I would like to offer a few observations about the origins of the Asian crisis and the most promising prescriptions for it, and to briefly describe for you some aspects of what could be the new architecture of the system.
On the origins of the crisis, we must be quite circumspect. After all, claiming to know all the reasons behind it would require either a good deal of audacity or a distinct lack of seriousness. While it will be some time before we have a full picture of what occurred in Asia, it is certain that many of the factors that contributed to the turmoil had been identified and discussed well before the crisis broke.
Even though many of the individual ingredients of the crisis were known in advance, it was not foreseen what a volatile cocktail they would become. Why? Certainly, when economic conditions are good and capital is flowing at a record pace and on very attractive terms, it is hard to imagine that the downside risks--so evident in the abstract--will ever materialize. On the contrary, it is easy for governments and investors to believe that the good times will continue and that correcting external imbalances and structural problems can safely be postponed until politically more convenient times.
That is just putting things off until tomorrow. Moreover, strong economic performance can mask the extent of a country's economic vulnerabilities. Especially when transparency is lacking, a country's situation may only be revealed for what it really is after market sentiment shifts. This constitutes the first of the lessons of the crisis, and one which those who have been spared this time might do well to consider.
Beyond this, the experience in Asia illustrates how financial situations can become self-perpetuating. Indeed, once the crisis broke in Thailand, markets took a closer look at the problems in Indonesia, Korea, and other neighboring countries. And what they saw to different degrees in different countries were many of the same problems, particularly in the financial sector. Meanwhile, inadequate data and disclosure--along with a sense that negative information, such as key data on international reserves, was being withheld from the market--deepened concerns about the genuine severity of these countries' problems.
Added to this was the fact that as currencies continued to slide, the debt service costs of the domestic private sector continued to mount.
Moreover, the way in which countries react to a shift in market sentiment can also have a critical effect on the course of future events. In recent months there have been several examples of emerging market economies outside of Asia that have successfully defused exchange rate pressures by taking quick and forceful action to raise interest rates or tighten fiscal policies, or both, if necessary. For them, what appeared to be a very real threat of contagion soon receded. In Asia, on the other hand, we saw how periods of political uncertainty and actions that cast doubt on the authorities' ability or resolve to address problems can cause the crisis to deepen and spread.
In many respects, this deepening of the crisis in some countries and its contagion to others reflects rational market behavior. But certainly the amount of exchange rate adjustment of the Thai baht, the Indonesian rupiah, and the Korean won, among other currencies, far exceeds any reasonable estimate of what might have been required to correct their initial overvaluation. In this respect, the markets have overreacted. But the fact remains that even though its extent and timing are hard to predict, contagion does not strike out of the clear blue sky. As I have indicated, there are reasons why a crisis spills into some markets and not others.
But before I come to what countries can do to avoid such contagion, let me say a few words about the programs that Thailand, Indonesia, and Korea have put in place with the support of the IMF, the World Bank, and others, as this marks a fundamental turning point.
In short, the three programs particularly reflect a change in the traditional design of our programs; their emphasis is now much less on the austerity measures required to restore macroeconomic equilibrium and much more on a package of firm, forceful measures of considerable structural scope aimed at establishing the conditions for sustainable growth in the new context of globalization.
These programs genuinely endeavor to attack problems at their roots, including their institutional roots. They are aimed at strengthening financial and governance systems, increasing transparency, opening markets, and, in so doing, restoring confidence.
To this end, nonviable financial institutions are being closed down, and other institutions are being required to come up with restructuring plans and comply, within a reasonable period, with internationally accepted best practices, including the Basle capital adequacy standards and internationally accepted accounting practices and disclosure rules. All these programs entail institutional changes to strengthen financial sector regulation and supervision, increase transparency in the corporate and state sectors, create a more level playing field for private sector activity, eliminate monopolies and cartels, and increase competition.
None of this will be easy, and it is important to get on with these tasks as quickly as possible so that confidence will be restored without delay and the economic adjustment will ultimately be less painful. And, indeed, these tasks must be carried out, as difficult as this may be in a context of economic slowdown, the consequences of past errors, and the sudden reversal of capital flows.
But what can countries that have still been untouched by the crisis do to avoid it and to maintain market confidence? Allow me simply to highlight three points that emerge from the most recent experience in Asia. First, countries have to guard against complacency concerning their economic problems and take an even more critical look at how they could reduce their vulnerability to a sudden change in market sentiment. In this regard, the first line of defense against crisis and contagion is a sound macroeconomic policy framework that promotes growth by keeping inflation low, holds the budget deficit in check, and favors a sustainable current account position. Even within such a framework, it is sometimes difficult to deal with large short-term capital inflows when these are a response to high domestic interest rates and exchange rate flexibility is limited. There is no easy answer to this problem, but the first response should be a tighter policy stance. Another option is to increase the flexibility of the exchange rate.
Second, countries must strengthen their financial sectors. In our surveillance, the Fund has had many opportunities to observe the causes of banking sector problems, including poor internal governance, a lack of transparency about operations and financial condition, government interference in credit decisions, and official complacency about problem banks. Left unaddressed, these problems can be extremely costly, not just for the country concerned, but for other countries as well. A sound financial system is a prerequisite for sustained growth, but a weak financial system is both a standing invitation to crisis and a guarantee of its severity.
Third, the benefits of greater transparency for macroeconomic and financial stability cannot be over-emphasized. When such information is available, policymakers have more incentive to pursue sound policies, and banks and corporations have more incentive to manage their firms prudently. Moreover, markets adjust more smoothly, and countries are less vulnerable to adverse market reactions when bad news eventually comes to light.
Even though we are, so to speak, in the eye of the hurricane, we need to take our analysis beyond the current situation and determine how it might be possible, in light of this crisis and these dangers, to strengthen the system so as to ward off new perils or, should they occur, to combat them more effectively.
In this connection, I would like to mention seven elements, which we could look upon as seven pillars to strengthen the architecture of the international financial system. The first such pillar is good governance and intensification of the fight against corruption.
Second, we are continuing to look for ways to make our surveillance more effective and to enhance transparency. The International Monetary Fund must be more ambitious and demanding about the data provided to us and communicated to the markets. Among other things, we need to know more about the structure of countries' external debt, their reserve levels, how highly leveraged their corporate sector is, and the level of nonperforming loans; and so do governments and markets. The Special Data Dissemination Standard, to which over 40 countries have now subscribed, provides a useful vehicle for encouraging countries to put out more information in the public domain. Now countries need to bring their data practices up to the specified standard as quickly as possible. We must also consider whether there are other types of information that should be added to the standard.
Third, financial and banking systems, as well as their supervision, must be strengthened. Over the past year or so, the Fund has been working to help develop and disseminate a set of "best practices" in the banking area, so that standards and practices that have worked well in some countries can be adapted and applied in others. We must continue this work.
Fourth, we must promote more effective regional surveillance. It is very encouraging to see such initiatives under way in Asia, since experience shows that there is considerable scope for improving policies when neighboring countries get together on a regular basis to encourage one another to pursue sound policies. The Fund stands ready to contribute its technical expertise to these efforts, as it already does in the G-7 and other fora.
Fifth, we must continue to liberalize international capital flows. This is fully in keeping with the remarks of the Chairman of the Group of Twenty-Four, who has proposed what is really a bold and creative mix of audacity and sound judgment. We have to liberalize capital flows--but in an orderly manner. The Asian crisis has cooled the enthusiasm for liberalizing capital flows that was so evident in Hong Kong. And although many may wish to evaluate it in light of the crisis, there are solid reasons not to abandon the effort.
Indeed, the East Asian countries have pursued a wide range of approaches to capital account liberalization. But their experience confirms the approach we have emphasized for a long time--that is, that capital account liberalization must be undertaken in the context of appropriate macroeconomic and exchange rate policies and with due regard for the soundness of financial systems and the proper sequencing of reforms. As the President-elect of Korea, Kim Dae-Jung, told me recently, we must not let the Asian crisis intimidate us. After all, it was not capital account liberalization that contributed to the destabilization of Asian economies, but disorderly capital account liberalization. Indeed, some Asian countries could have benefited from a more rapid capital account liberalization, as faster progress in liberalizing direct foreign investment could have made for a better balance between short-term credit inflows and longer-term equity inflows. Likewise, faster capital market reforms could also help develop the markets for hedging and managing risks, essential parts of modern financial markets that have been sorely lacking in many Asian economies. But we should not sacrifice freedom on the basis of illusions about the lasting effectiveness of controls.
Sixth, we have to see whether better ways can be found, in crisis situations, to involve the private sector in official efforts to resolve debt crises and avoid the problem of moral hazard, perhaps through orderly mechanisms for settling and restructuring debts. We must give clear priority to this task.
Finally, the seventh pillar is to significantly strengthen multilateral institutions, by ensuring more equitable representation of all countries on their boards, bolstering their authority, and, of course, enhancing their resources.
As you can see, the IMF has a very full agenda before it. And to this agenda we must add the need to move forward with implementation of the HIPC Initiative.
