"Asia and the IMF"

September 19, 1997

Seminar Schedule

IMF In Asia
Concluding Remarks

P. R. Narvekar

My assignment at the end of this day is to offer some "Concluding Remarks." I could try and pull together the main themes of the discussion during the day and give my reactions. But, I think that would be presumptuous, since members of this very educated audience are certainly capable of pulling together the strands themselves. And, I am not comfortable with giving my own reactions at this stage to the rich discussion we have had, reactions which would be in the nature of instant responses without the benefit of careful thinking. I shall, therefore, do something a bit different and that is to sketch out briefly, and I am afraid randomly, my own recollection of aspects of the Fund's relations with some Asian countries over the past several decades, and the likely evolution of these relations in the future. What I have to say will naturally be a bit subjective.

I must note, first of all, that it is difficult to talk about all of Asia in one breath. I am aware that some -- and they are thoughtful and learned people -- speak about one distinct "Asian culture" as being a way of thinking and living which is characteristic of the large majority of people living in the geographical region known as Asia. I happen to not quite agree with this view -- to me, it is the diversity of people in Asia that is the more striking -- and at the level of international comparison -- perhaps its unique feature. But fortunately, on this occasion one does not need to get into that rather politically sensitive controversy. I am sure everyone will agree with the more immediately relevant statement that the diversity of the various national economies in Asia makes it of limited use to talk about them together.

This diversity means that the Fund's relations with the Asian countries are quite variegated, depending on the country one is talking about. This has always been so and I believe it remains so today; it will take a very long time indeed for the convergence theory to work itself out here. The discussion today has focused almost exclusively on Southeast Asian countries, for good reason. But, of course, there is much more to Asia than these Southeast Asian countries, and over the years the Fund has had relations with almost all Asian countries.,As interesting as each individual Asian country is, naturally I cannot speak about all of them. I shall speak briefly about Japan, China, India, and the ASEAN countries which have been so much in the news lately.

I suspect the organizers of the seminar didn't think Japan should be discussed very much here today -- for quite understandable reasons -- but I could be forgiven for some reference to it because it was with Japan that I began my career in the Fund. Those were the days when Japan still needed to borrow from the Fund. I doubt that Japan, like the other G-7 countries, will ever be in that position again, although we in the Fund periodically engaged in exercises designing schemes that would entice these countries into borrowing from the Fund. Indeed, Japan has been for quite some time now, and I am sure will remain, a major contributor to the financial resources of the Fund. It has supported the Fund's role in the world economy in numerous other ways -- most recently in the prominence it insisted on giving to the Fund in designing a rescue operation for Thailand. At an intellectual level, Japan has made a contribution by challenging the neoclassical view of the policies that have led to the economic success of the East Asian countries. I myself happen to believe in the validity of the neoclassical view but I cannot deny that the challenge has made a contribution to our understanding.

There are next, the two giant countries -- although not yet giant economies on a global scale -- China and India. It is almost exactly to the day 17 years ago that the People's Republic "assumed its seat" in the Fund --- that is the Fund jargon. This was after a lapse of some thirty years, a period during which Fund staff didn't -- indeed it wasn't allowed to -- even study the (Mainland) Chinese economy. Thus met on the one hand, one of the two largest centrally planned economies in the world and on the other, an "outside" financial institution. Naturally, there then followed a period of intense effort at mutual discovery -- such a process never ends, of course. In any event, during this 17-year period, the Chinese economy expanded vastly and transformed itself substantially. The Fund has worked with the Chinese authorities throughout this period in a number of ways, mostly by providing policy advice and technical assistance on a very broad range of issues. Naturally, the Fund, too, learned a good deal in the process of this broad engagement -- about introducing a market orientation into a centrally planned economy and about stabilization and growth of such an economy.

Of China's rapid growth in recent years it has been said that never in history has the condition of so many millions been improved so dramatically in so short a time. This must be true essentially, even if one made allowance for the doubts of some experts regarding the quality of the underlying data. This rapid economic growth was not without sharp ups and downs, however, and there was concern in the Fund, as elsewhere, about this feature of the Chinese economy. But by now China seems to have begun to master the art of soft-landing; its handling of the most recent downturn was indeed an impressive achievement. Beyond these cyclical fluctuations, if what the Fund's Managing Director calls sustainable high quality growth has to continue in China, many more policy reforms would be needed belonging to both the first and the second generation of reforms, using a taxonomy made familiar, also by the Managing Director.

In this task, I am sure the Fund will have a role. Given China's large foreign exchange reserves, recently bolstered by Hong Kong, it may well be that China will not need financial assistance from the Fund. But I believe China will continue to find useful, in the very substantial reform task it has ahead of it, the policy advice and technical assistance that the IMF can give. At the same time, there is little doubt that before very long, the Chinese economy will become one of the largest in the world and that China will exert an even greater influence in the Fund as an institution than it has done hitherto.

Of course, this last can also be said about at least a few more countries in Asia, India prominent among them. Present at the creation, India has always been an important member of the Fund. However, its role clearly shrank as its domestic economic policies failed to deliver what their authors expected of them. And the authors of these policies could not muster the flexibility, and India's body politic could not mobilize the broad support, that were needed to make a decisive turn away from those policies. I cannot say that the Fund itself pushed particularly hard in that direction either, although, of course, that was certainly the direction in which its advice was tilted. The devaluation of the rupee in 1966 strongly urged by the Fund -- and widely seen as such -- was not well managed. Also, it was followed by a severe drought which created major supply difficulties. The result was that the devaluation was seen as a failure, at least in the short run, and, fairly or not, this did nothing for the reputation of the Fund in the country.

Twenty-five years later, another balance of payments crisis shook not only the economy but this time also the intellectual underpinnings of the policy framework in which the economy operated. Subsequent events have shown nevertheless how difficult the most motivated and vigorous leaders can find it to free an economy caught in the midst of clashes between vested interests. This is especially true if there is at the same time a determination to let these conflicting interests be expressed in and resolved through the democratic process. This "compulsion to make democracy work in spite of economic adversity, to sustain democracy while struggling to achieve prosperity," in the words of a political commentator, is, of course, the value judgment of a whole people.

Nonetheless, what has been achieved in the past half a dozen years is truly remarkable. The rate of growth of the economy has finally broken loose from its Hindu shackles. Inflation is low. The national savings rate is increasing. The cushion available to the economy against unexpected shocks, in the form of foreign exchange reserves and food grain stocks, has substantially thickened. Nevertheless macroeconomic stabilization is not yet nearly complete and interest rates cannot come down as long as the public sector deficit remains as high as it is. If the economy is to rise to a higher and sustainable growth path and a bigger dent is to be made in poverty, a long structural reform agenda also needs to be tackled which, especially in the present political situation, looks particularly challenging. These are areas in which, naturally, the Fund could be working with the authorities.

Let me now digress for a moment to elaborate a bit on a subject that I just referred to in passing -- the subject of poverty. It is appropriate to speak of this subject in the context of India for, while poverty is the most fundamental problem of all of Asia, the poverty rate in India is perhaps the highest of all countries in the continent, and a very large proportion of the Asian poor live in India. Despite considerable progress in recent years, about a billion people, or one-third of Asia's total population, still live in poverty. A billion people, a number greater than the number of the poor in Latin America and Sub-Saharan Africa together! I should also note that there is increasing evidence that inequality of income distribution is on the rise in several Asian countries. I believe that these are facts of the Asian situation that the Fund cannot but take into account in its dealings with Asian countries; or, looking at the same matter from the other side, the fact that the Fund is paying increasing attention to poverty and income distribution issues in its policy advice to countries should only be gratifying to their authorities.

Before moving on, let me touch briefly on another aspect of national policies and administration which the Fund has now begun to bring under sharper focus in its policy advice or conditionality. I refer to good governance. Very few countries in the world can claim that they have no concerns in this area, and Asian countries are no exception. In order to step up the pace of social and economic progress, the Fund is now recommending to countries a ' second generation of reforms' in which good governance is an important element. It is gratifying to see that all over the world, including in the biggest countries of Asia, this problem -- which has finally crossed the threshold of public tolerance -- is being taken seriously by national governments. Asian countries' support of new initiatives in this area by the Fund will redound to their own benefit.

Let me turn now to that group of South East Asian countries, all members of ASEAN, on whom global attention has been focused for the last few months as a result of the currency and financial market turmoil in that region. These have been, of course, among the best performing economies in the world over the past decade, a beacon of inspiration and indeed hope to all developing countries, and a source of some wonder and much concern to at least some of the others.

These are countries -- Indonesia, Malaysia, Philippines and Thailand -- with which the Fund has had very close relationship over the years. The relationship with Indonesia broke down once in the mid- sixties, the country, in fact, withdrawing from the Fund but returning to the fold fairly soon. A period of extraordinarily close relationship came thereafter, which has continued to this day. However, the substantial use of Fund resources, a feature of this relationship in the early years, became redundant after the oil price rise of 1974. The Malaysian and Thai economies had their problems now and again but the use of Fund financing was strictly temporary. And, finally, all these countries became star economic performers, with enviably rapid rates of growth; impressive diversification of their economic structures; and reduction in poverty, especially in Malaysia. The Philippines, however, limped behind. Its troubles began in the late 1950s and continued for a long time, the country becoming a protracted user of the Fund's financial resources. A dramatic transformation in the country's economic situation occurred in the last several years, however, and the country has appeared of late to be on the threshold of graduating from its status as a continuous user of the Fund's resources.

The growing economic and external payments strength of most of the ASEAN countries had begun to generate some discussion in the Fund about how to maintain the Fund's relevance to these countries. The issue disappeared, however, as the rapid growth of these countries began to result in strong overheating problems, presenting a surveillance challenge to the Fund of persuading these countries to restrain the expansion of their economies.

There has been some discussion in the press whether in this instance the Fund discharged this surveillance function adequately or in time. I shall not enter that controversy here, although I do have a view on it, as you would expect! Nor do I think it necessary to recount for this audience the economic circumstances and the policy postures that resulted in the overheating of the economies, and the eventual currency turmoil.

This currency crisis, coming so soon after Mexico, the policy and procedural reforms made at the Fund as a consequence of Mexico, and the apparently successful handling of Mexico, the Southeast Asian turmoil, coming so soon after all this, raises a number of questions. Among them are these: Is the broad consensus, that many perceived to have developed around a certain set of "right policies" that could achieve good fundamentals, really misplaced? Should countries try to shut off the forces of globalization -- a "withdrawal from modernity" as it were? Was the "economic miracle" of these countries only an illusion, and is one to expect that their future performance would be no better than average?

In my view, there is no reason to be permanently discouraged. At the same time, from this experience both these countries and the Fund, must draw lessons. In any event, in the coming years this experience is bound to influence in an important way the nature of the relations between the Fund and these countries. Let me now touch on a few of these lessons.

First and foremost, this experience has in no way invalidated, indeed, it has underscored, what we would consider basic macroeconomic truths. Pursuit of economic growth rates that are achievable in the shortrun but unsustainable in the long run, which is financed by large capital inflows and/or excessive monetary expansion, are certain to lead to overheating reflected in asset price inflation, current price inflation, and widening current account deficits. The denouement also comes predictably: a sharp slowing of growth, increased unemployment, and damaged confidence.

Second, unwillingness to move exchange rates was an important contributor to the recent difficulties in Asian countries. It has recently been argued that the Asian experience was not unique; that there are, indeed, special characteristics of emerging markets (having to do with the structure and denomination of their debts) that make fixed exchange rates highly dangerous. The Asian experience does indicate the need for a continued exploration of the issues involved, and the policy options available to countries in different situations, structural and cyclical. While I have not yet had the opportunity to see it yet, it seems to me from press reports that the current issue of the WEO deals with these matters incisively. Frederick Mishkin's paper could be another point of departure. The important thing in my view is flexibility -- I do not mean flexibility of exchange rates -- although that might very well be needed in particular situations -- but flexibility of attitude on the part of the authorities to the appropriate exchange rate policy in different circumstances.

Third, a lot needs to be done to inculcate sound banking practices and institute effective supervision of banks and financial institutions. Failure in this area, leading to the large accumulation of nonperforming loans has been a critical factor in the recent difficulties. More generally, it has become apparent that almost everywhere in Asia sound financial sector development has not kept pace with real sector development, and high priority needs to be given to building stronger financial systems.

Fourth, more work needs to be done on the subject of recognizing potential financial crises or measuring financial vulnerability. Morris Goldstein has recently identified "seven deadly sins" but human beings, and even policymakers, are certainly capable of committing many more!

Finally, the contagion effects in the recent Asian episode demonstrate how even relatively small weaknesses in fundamentals -- after all, most of us spoke about how strong the fundamentals in these countries were -- weaknesses not by themselves enough to cause a currency panic, were quite enough to attract contagion from trouble spots elsewhere in the region.

The passage of time and closer analyses of the recent experience will yield more lessons that we need to take to heart. My main point now is to emphasize, in light of the issues just raised, how substantive and weighty the interactions between Asian countries and the Fund will be in the years to come. Of course, each country can draw the lessons by itself but it is the role of the Fund par excellence to bring the benefit of the experience of one country to all the others. And this brings me now to a suggestion. Let me say at once that I claim no originality for it.

In the recent past, Asian countries have been making various efforts at regional or subregional cooperation. As far as this involves regional or subregional trade liberalization, I doubt that it is always a very good idea. But other forms of cooperation, including monetary cooperation, can be of benefit. I do believe that groups of countries in the Asian region should try to set up arrangements in which periodically -- let us say twice a year -- top economic policymakers of the participating countries would assemble to review economic developments in individual countries and in the region as a whole, against the background of world economic developments. Such meetings could provide the occasion, in particular, to discuss common problems and opportunities and to bring peer pressure on individual countries to deal with emerging problems before they become more serious and engulf the whole region. Such meetings should be serviced by a secretariat; it would probably be economic and efficient, at least initially, if the Fund staff were to be invited to provide a brief background paper for discussion by participants. In any case, the Managing Director of the Fund could be invited to participate in the meetings in his personal capacity.

Of the three questions I had raised moments ago, two are still unaddressed. The question about shutting off the forces of globalization was to a large extent rhetorical; my answer would be 'no.' But I did load the question by using the phrase "withdrawal from modernity" and thus presenting the matter as an all -or- nothing choice. In an interesting article published earlier this year Sasakibara has argued that there is another option: A new paradigm in which many aspects of Western market capitalism are combined with elements drawn from the global economic system which existed centuries ago and in which Asia and the Middle East played a crucial role. Like all marriages, this is also an exciting idea but I am afraid I can say no more at this stage.

Finally, I must address briefly the question about the outlook for future growth of the miracle-performing countries. Some analysts question whether there was ever a miracle at all; others consider that the performance of these economies had relied excessively on capital formation and must hereafter slow substantially. I, for one, am impressed by the argument of those that have pointed out that in most East Asian countries, the stock of capital per unit of labor is still very much smaller than that in the more advanced countries that the quality of the labor force will improve automatically as a result of demographic factors. These facts, together with the high savings rates in these countries, an ample and capable entrepreneurial class, and -- notwithstanding the recent failure -- the commitment of these countries to macroeconomic stability, all give hope for the future. Couple this with the expectation, as expressed in a recent AsDB study, that South Asia is now in a position to substantially accelerate its growth, and then one can be optimistic about the future of the continent. Of course, I do not deliver such optimism without a dash of caution. What we have before us is an opportunity -- it is for individuals and institutions to turn it into reality. But I cannot believe that the salience of Asia on the world scene in the last few decades was only a transitional episode, withering away with time.