The IMF and the Asian Crisis - Address by Stanley Fischer

IMF News, March 20, 1998

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Published: March 20, 1998

The Purposes and Role of the IMF

Primary purposes (Article I) include:
- "To promote international monetary cooperation through a permanent institution which provides the machinery for consultation and collaboration on international monetary problems";
- "To facilitate the expansion and balanced growth of international trade, and to contribute thereby to the promotion and maintenance of high levels of employment and real income ...";
- "To promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation";
- "To assist in the establishment of a multilateral system of payments in respect of current transactions ... and in the elimination of foreign exchange restrictions which hamper the growth of world trade";
- "To give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards, thus providing them with opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity."
Institutional role and capabilities:
- Forum for international economic cooperation with 182 member countries.
- Staff includes 1000 economists, 450 of them with Ph.Ds.
- Major activities: surveillance, lending, technical assistance, policy advice, data standards.
- Surveillance outputs include the semi-annual World Economic Report, annual International Capital Markets report, and Article IV consultations (Article IV reports are not published by default; 60 PINs containing Chairman’s summing-up and other information have been published).

Surveillance, Data, and Crisis Prevention

Surveillance and limitations:
- Fund warned Thailand of impending crisis but failed to foresee the virulence of contagion.
- Surveillance can fail when warnings are not heeded or crises are not anticipated.
- Public warnings are constrained by confidentiality concerns and the risk of provoking crises.
Recommendations and ongoing work:
- Improve flow of timely, accurate, and comprehensive data to the public (Special Data Dissemination Standard).
- Strengthen data on forward transactions by central banks and short-term debt exposures of banks and corporations.
- Improve capacity to interpret data: research into crisis indicators and official/private surveillance.
- Enhance Fund surveillance effectiveness by ensuring all relevant data is supplied and by evaluating exchange rate regimes and sustainability of capital inflows.

Fund Lending, Quotas, and Facilities

Quotas and resources:
- Total quotas "now amount to a bit under $200 billion."
- Members pay in 25 percent of their quota as the reserve tranche.
- September 1997 agreement: increase quotas by 45 percent, about $90 billion; U.S. share of the increase nearly $14.5 billion.
- U.S. congressional requests referenced: quota increase and $3.5 billion for the United States contribution to the New Arrangements to Borrow (NAB).
- NAB: participants 25; doubles resources available under the General Arrangements to Borrow.
Lending modalities:
- Fund operates like a credit union; loans are typically tranched and conditional on meeting agreed policies.
- Stand-by arrangement: usually lasts 12 to 18 months for temporary or cyclical balance of payments deficits.
- Extended Fund Facility (EFF): supports three to four-year programs.
- Enhanced Structural Adjustment Facility (ESAF): concessional financing for low-income countries.
- Supplemental Reserve Facility (SRF): created December 1997 to assist emerging market economies; allows large short-term loans at higher rates. First borrower under the SRF was Korea.
Program design principles:
- Fund-supported program should ideally be the country’s own program and reflect government commitment.
- Conditionality and tranche disbursement act as "adequate safeguards" required by the Articles of Agreement.
- Transparency about programs (e.g., publication of Letters of Intent) is encouraged to build public support.

Origins and Dynamics of the Asian Crisis

Pre-crisis strengths and vulnerabilities:
- ASEAN-5 annual GDP growth averaged close to 8 percent over the last decade prior to the crisis.
- Prior 30 years: per capita income increased tenfold in Korea, fivefold in Thailand, fourfold in Malaysia; Hong Kong and Singapore per capita income levels exceed those in some Western industrial countries.
- Asia attracted almost half of total capital inflows to developing countries—nearly $100 billion in 1996.
Structural vulnerabilities identified:
- Signs of overheating: large external deficits, property and stock market bubbles.
- Pegged exchange rate regimes maintained for too long encouraged heavy external borrowing and unhedged foreign exchange exposure.
- Lax prudential rules and weak financial oversight led to deteriorated bank loan portfolios.
External contributors:
- Weak growth in Europe and Japan kept interest rates low, encouraging large private capital flows (including carry trade).
- Wide swings in the yen/dollar exchange rate over the previous three years.
Crisis transmission:
- Thailand’s crisis was predicted in broad terms; denial and lack of convincing policy action delayed needed adjustment; baht floated in July 1997.
- Contagion mechanisms: competitive pressure on currencies, reappraisal of financial sector weaknesses in neighboring countries, increased domestic debt service costs as currencies depreciated, hedging behavior intensifying pressures.
- Markets "overreacted" producing depreciations "by a wide margin" beyond what corrected initial overvaluations required.

IMF Programs in Thailand, Indonesia, and Korea: Macro and Structural Policies

Common problems across the three countries:
- Loss of market confidence, deep currency depreciation, weak financial systems, excessive unhedged foreign borrowing by domestic private sector, and lack of transparency in government-business-bank ties.
Macroeconomic prescription and rationale:
- Priority: restore confidence in the currency; implies temporarily increasing interest rates to make domestic currency more attractive.
- Rationale against larger devaluations: companies with substantial foreign currency debt suffer more from steep domestic currency slides than from temporary higher domestic interest rates; excessive devaluations create large current account surpluses harming other countries.
- Fiscal tightening examples:
- Indonesia: fiscal adjustment of one percent of GDP.
- Korea: fiscal adjustment of 1.5 percent of GDP.
- Thailand: initial fiscal adjustment of 3 percent of GDP (reflecting a current account deficit of about 8 percent of GDP).
- Treatment of financial sector restructuring costs: expected interest costs of intervention included in fiscal calculations; example—if cleaning up the financial sector costs 15 percent of GDP, corresponding fiscal adjustment would be about 1.5 percent of GDP.
- Automatic stabilizers: Fund generally agreed to allow deficits to widen somewhat if the economic situation weakened more than expected, letting automatic stabilizers operate.
Structural policies central to programs:
- Financial sector restructuring (recapitalize or close insolvent banks, protect small depositors, require shareholders to take losses).
- Improve banking regulation and supervision, corporate governance, transparency, and market institutions.
- Link to World Bank: longer-term structural reforms typically financed by World Bank loans; many structural measures lie in World Bank purview.
Pace and country-specific tailoring:
- Programs take individual country circumstances into account regarding speed of recapitalization and structural reform implementation.

Moral Hazard, Private Sector Losses, and Bail-in Issues

Moral hazard dimensions:
- Two concerns: policymakers taking excessive risks knowing IMF will rescue; investors not pricing risk properly because of IMF backstop.
- Fischer’s assessment:
- Most countries try to avoid going to the Fund; conditionality provides incentives to act responsibly.
- Access to Fund should not be "too easy"; Fund should not be lender of first resort.
Evidence on investor losses:
- Foreign equity investors by end-1997 had "lost nearly three quarters of the value of their equity holdings in some Asian markets."
- Many firms and financial institutions will go bankrupt; foreign and domestic lenders will share in losses.
- Fourth-quarter earnings reports indicate the crisis has been costly for foreign commercial banks.
- Some short-term creditors were temporarily protected via policies aimed at rollover; in Korea creditor banks were "bailed in" with successful rollovers and lengthening of loans.
Role of IMF lending:
- IMF lending is lending, not grants; helps moderate recessions and can reduce hardship for residents, corporations, and some lenders relative to no official support.
- Objective: design lending to avoid creating wrong incentives; seek ways to discourage unwise private lending and share burden between official and private sectors.
Need for better private sector involvement mechanisms:
- Consideration of bail-in arrangements, international bankruptcy procedures, and temporary stay on payments; legal and contagion challenges remain.

Architecture of the International Financial System — Reforms and Agenda

Crisis prevention (five points):

1. Increase flow of timely, accurate, comprehensive data to the public (Special Data Dissemination Standard); strengthen standard to include forward transactions by central banks and short-term debt exposures. 2. Enhance effectiveness of Fund surveillance: ensure relevant data supplied, assess consistency of exchange rate regimes, and evaluate sustainability of capital inflows; debate over whether Fund should issue more public warnings. 3. Strengthen domestic financial systems: disseminate best practices and encourage adoption of the Basle Committee’s 25 core principles for banking supervision; develop mechanisms to monitor implementation. 4. Improve operation of capital markets: encourage international standards (bankruptcy codes, securities trading, corporate governance, accounting) and monitoring of implementation; consider risk-weighting incentives tied to compliance. 5. Prudently sequence capital account opening: neither pervasive capital controls nor immediate full liberalization; macroeconomic balance and strong supervised financial systems as prerequisites; IMF working on a charter amendment to make liberalization of capital movements a Fund purpose.

Crisis response:
- Emergency Financing Mechanisms streamlined IMF internal procedures (enabled Korea program negotiated, signed, and approved in less than two weeks).
- Supplemental Reserve Facility tailored to emerging market crises.
- Continued search for mechanisms to involve private sector timely (bail-in question); exploring international bankruptcy/code ideas and temporary stays on payments.
Resources:
- IMF requires adequate resources to perform prevention and management roles; increase in IMF quotas is highlighted as important.

Key Numerical Facts and Figures (preserved exactly)

IMF membership: 182 member countries.
IMF staff: 1000 economists, 450 of them with Ph.Ds.
Executive Board members: 24; majority required for most major decisions: 85 percent.
U.S. share of Fund votes: "about 18 percent of the shares."
Total quotas: "a bit under $200 billion."
Quota increase agreed September 1997: 45 percent, about $90 billion.
U.S. share of the increase: "nearly $14.5 billion."
U.S. contribution request to NAB: $3.5 billion.
NAB participants: 25.
ASEAN-5 annual GDP growth averaged "close to 8 percent" over the last decade prior to the crisis.
Asia capital inflows in 1996: "nearly $100 billion."
Examples of fiscal adjustments:
- Indonesia: "one percent of GDP."
- Korea: "1.5 percent of GDP."
- Thailand: "3 percent of GDP."
Thailand current account deficit: "about 8 percent of GDP."
Hypothetical financial sector cleanup cost example: "15 percent of GDP" → corresponding fiscal adjustment "about 1.5 percent of GDP."
Yen-dollar exchange rate example: "between 81 in the spring of 1995 and 133 late last year."
By end of 1997 foreign equity losses in some markets: "nearly three quarters of the value of their equity holdings in some Asian markets."
SRF creation: "December 1997."

Source: The IMF and the Asian Crisis - Address by Stanley Fischer, Los Angeles, March 20, 1998.