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For the IMF and Others, Lessons From the Asian Crisis - A Commentary
January 20, 1999
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International Herald Tribune
January 20, 1999
Backed by international assistance, some of the troubled East Asian economies now have recovery in sight. Renewed market confidence has strengthened weakened currencies, interest rates have fallen - in South Korea and Thailand to below pre-crisis levels - and recessions appear to be bottoming out.
From the outset, the crisis has been fraught with controversy, in particular about the role of the IMF. Now, with signs that the worst may be over, it is time to examine the lessons.
The IMF is making its contribution to this debate in a report entitled ''IMF-Supported Programs in Indonesia, Thailand and Korea: A Preliminary Assessment.'' Released this Tuesday, it looks at how the crisis developed, the policy responses in Thailand, Indonesia, and South Korea, and the early results of programs supported by the IMF with the cooperation of the World Bank, the Asian Development Bank and bilateral creditors.
The report is intended to increase public understanding of the IMF's role in the crisis, and widen discussion of two other important issues: how to prevent future crises and handle those that may erupt.
The problems confronting the Asian crisis countries had many novel aspects. Of critical importance was weakness in the financial and corporate sectors that made them particularly vulnerable to sudden shifts in international financial flows. These fragilities, which had grown even as large amounts of foreign capital flowed in, were caused by weak financial supervision and other structural problems, and poor risk management by creditors.
The crisis quickly turned into a vicious circle. Capital outflows pushed the value of currencies downward, creating risks of insolvency for companies that were indebted in foreign currencies and adding momentum to capital outflows. In a global financial market linked by almost instantaneous communications, money moves with a speed that leaves policymakers little room for hesitation.
The unusual nature of the problems called for broad-ranging remedies. IMF-supported programs attacked the underlying structural problems that caused the crisis. They attempted to break the vicious circle of capital outflows and currency depreciation, while dealing promptly with its immediate financial and social fallout.
Without a heavy emphasis on structural reforms, the programs would have been a costly effort to treat symptoms without addressing causes.
Another key focus was creating or strengthening social safety nets to help the people most painfully affected by the crisis. In this area especially, the IMF worked closely with the World Bank and the Asian Development Bank.
The immediate instability left little choice but to take tough monetary action to overcome the risk that rapidly weakening currencies would trigger a cycle of depreciation and inflation. At the same time, policies had to avoid excessive tightening, because this, too, could undermine recovery.
Currencies continued to fall initially, but exchange rates strengthened again as monetary policy was tightened and market confidence recovered. Interest rates then eased.
Budget policy sparked a controversy far beyond the economic impact of modest initial tightening.
When the programs were launched, some tightening was warranted, not least to meet part of the heavy costs of financial sector restructuring. This was based on the prevailing view at the time that these economies would experience a slowdown in growth, but not a deep recession. This tightening was reversed when the recessions turned out to be deeper than expected and it became clear that expansive budget policies were needed.
Still, in discussing the report, some of the IMF's executive directors expressed the view that a stronger fiscal stimulus should have been delivered more promptly as the true extent of the economic slowdown became apparent.
The initial programs assumed that policies would bring a reasonably quick return of investor confidence. But, for a number of reasons, including political developments and problems in the way the substance of the programs was communicated to the markets and the public, events turned out otherwise. Capital continued to exit even after the programs were introduced. This withdrawal of foreign financing forced the economies into massive adjustments at the price of severe recessions.
The behavior of capital flows points to some of the lessons that need to be drawn from the crisis. The fact that so many external creditors could pull their money out at short notice was one of the main reasons why the crisis began and continued to spread. It also meant that, once the crisis started, the success of any policy response would hinge on how the markets reacted.
Could the crisis have been made less severe if the countries had imposed an involuntary debt restructuring on their creditors, accompanied by capital controls? This is attractive, but only superficially. A heavy-handed attempt to bail in private creditors in one country can add momentum to capital flight elsewhere.
These are examples of issues that are being examined carefully in connection with the current discussion on reforming the international financial system. The experience in Asia means that we have to look closely at possible ways of involving private creditors in resolving financial crises.
Another critical question is whether capital controls or prudential measures can limit short-term and potentially volatile capital inflows before a crisis erupts, reducing vulnerability to a shift in market sentiment. More generally, what is the right way for a country to open up to foreign capital?
The crisis also points to the need for creditors to have better information so that they can do a better job of managing risk. This concern is reflected in current international efforts to improve economic data, make budgets and monetary policy more transparent, and build on internationally agreed standards in accounting, disclosure, bankruptcy codes and other areas critical to the functioning of private markets.
