Wanda S. Tseng
ICAS Fall Symposium
965 Clover Court, Blue Bell, PA 19422
2. Today I would like to address some issues that have become subjects of public debate in the aftermath of the Asian crisis. Looking back, I will review:
3. The first question is what were the key causes of the Asian crisis? What led to the seemingly overnight change from the "Asian miracle" to the "Asian crisis"? The crisis had its origins in the complex interplay among domestic macroeconomic, structural, institutional, and political factors, as well as developments in the advanced economies and global financial markets.
4. As for domestic factors, the buildup of serious structural problems in the financial and corporate sectors, and, to varying degrees, inadequate macroeconomic policies caused the crisis in Asia. Overheating, arising from surging private sector demand, was reflected in real estate and stock market bubbles, and in Thailand particularly, in large trade deficits. Excessive investment financed by borrowing raised loan leverage ratios in the corporate sector to very high levels before the crisis -- the average debt equity ratio in 1996 was already 450 percent for the top 30 Korean chaebols and was approaching 200 percent for firms in Thailand. The high-gearing ratios made the corporate sectors vulnerable to shifts in financing costs or demand conditions. Pegged exchange rate regimes had been maintained for too long, encouraging large and unhedged external borrowing, including increasing amounts of short-term credit. Unhedged borrowing, in turn, created excessive exposure to foreign exchange risk in both the financial and corporate sectors. Inappropriate sequencing in financial sector and capital account liberalization was also responsible: the crisis countries opened up short-term financial flows while neglecting prudential oversight. Moreover, nontransparent ties between the government, the business sector, and financial institutions eroded market discipline in lending and borrowing decisions.
5. It would not be correct, nevertheless, to attribute the crisis in Asia only to domestic policy shortcomings. The external context must also be clearly recognized. Conditions in international markets and the behavior of market participants were also responsible. Private investors, attracted by the higher returns in the Asian countries (as well as their good policy track record), were less inclined to assess carefully the risks involved. This led many to lose sight of the steady appreciation of the dollar against the Japanese yen from mid-1995 that was contributing to a loss of export competitiveness of the Asian countries whose currencies were tightly linked to the U.S. dollar. Once the Thailand crisis blew up, it led the markets to reassess risks in all emerging markets -- a major factor in the broadening of the crisis (the contagion effect). The IMF was called in for help....always too late.
Design of IMF-supported programs
6. The policy programs to respond to crisis in Asian countries had to be speedily designed to deal with critical situations. The programs had the twin objectives of stabilization and recovery. It should be recalled that when Thailand and Korea approached the IMF, their reserves were perilously low, and the Indonesian rupiah was depreciating rapidly, confidence was disintegrating, and capital was flowing out fast. Thus, the first order of business was to restore confidence in the currency, so as to avoid the debilitating consequences of a depreciation/inflation spiral.
7. This takes us to one of the most controversial element in the IMF-supported programs -- that of interest rate policy. The question is raised whether the countries should have tried a different trade-off -- instead of raising short-term interest rates temporarily to stabilize the exchange rate as they did, they should have opted for lower interest rates and accepted a greater depreciation. Under the circumstances, the countries faced a burden either way: the temporary one of higher interest costs, or the permanent burden of servicing dollar debt with a much more devalued currency. The choice depended on how far the exchange rate had moved. At the time when the programs were being formulated, currencies had already overshot, and governments knowing full well the substantial unhedged foreign currency debts, quickly concluded the larger damage that would result from a permanent, steep slide in the value of the domestic currency. Instead, the strategy was to raise short-term money market interest rates temporarily, to help restore confidence in the currency, and to reduce interest rates as currencies strengthened. This is what happened in Korea and Thailand, with success in restoring confidence in the domestic currency, interest rates have come back to -- or below -- precrisis levels.
8. A related controversy has been over the cause of credit crunch conditions in many sectors, attributed by some to excessively high interest rates. While there is no doubt that cost factors have been important, and have put pressure on balance sheets of the corporate and financial sectors, it bears recalling that the broader structure of lending and deposit rates moved up only slowly, and by considerably less than the rise in short-term interest rates. More importantly, credit availability has been constrained by banks' need to conserve capital and contain nonperforming loans. In this context, we can look at the situation in Japan, where banks continue to be unwilling to lend, despite very low interest rates. Such risk aversion cannot be addressed simply by lowering interest rates, but is a much more complex phenomenon and will have to be tackled through fundamental financial restructuring, a subject I will turn to shortly.
9. Another controversy has risen over the role that could be played by capital controls. The proponent for such controls implicitly accepts the risks posed by lower interest rates for a weak currency, and acknowledges that currencies have already overshot, but seeks to disengage the trade-off, thus allowing interest rates to be lowered without additional exchange rate depreciation. Countries that are now doing everything possible to revive private capital inflows, partly to help recapitalize banks, have come out strongly against this approach. It is noteworthy that Chile, a country often cited for the effectiveness of its controls on short-term capital, has responded to the present situation by relaxing rather than tightening such controls in order to attract more capital. Also, capital controls are notoriously difficult to enforce, particularly in countries like Thailand and Korea that are integrated into the world financial markets.
10. Finally, there is a question of fiscal tightening, and whether this was over done at the start of the programs. The fact of the matter is that except for Thailand -- which faced a large current account deficit and the considerable slippage in the fiscal situation before the crisis -- the initial fiscal adjustment in the IMF-supported programs was small. The adjustments were designed to cover the interest cost of financial sector restructuring. Subsequently, as soon as the depth of the recession became evident, the programs were promptly adjusted to generate a fiscal stimulus.
11. The fact is that fiscal position, although measured differently from country to country, is projected to be in deficit this year by 3-4 percent of GDP in Korea and Thailand, partly to strengthen social safety nets. The fiscal deficit in Indonesia is now projected at 8 percent of GDP, in order to allow for much expanded expenditure on food subsidies and other measures to help the poor. At the same time, I should acknowledge that, in all countries, there have been difficulties restarting capital expenditures, and strong reluctance by the authorities to embrace industrial country-type social safety nets. Nevertheless, in all countries with IMF-supported programs, the fiscal stance is now expansionary, going beyond the automatic fiscal easing associated with the change in economic conditions.
12. Financial and corporate sector restructuring has been at the heart of the IMF-supported programs in Asia. This is necessary to deal squarely with the problems of weak financial institutions, inadequate bank regulation and supervision, highly leveraged corporations, and the nontransparent relations among governments, banks, and corporations, which were central to the Asian crisis.
13. In all the countries, failed financial institutions have been closed, and strategies are being developed for the restructuring and return to private ownership of institutions in which country authorities have intervened. The recapitalization of core banking systems is being pursued aggressively with the help of public funds, linked to strong restructuring plans, and with appropriate safeguards. These efforts are being driven by the phased adoption of international best practice standards, strengthened regulatory and supervisory frameworks, and liberalized conditions for foreign equity participation. In the past few months, these restructuring efforts have gained momentum.
14. Efforts are also under way in the Asian crisis countries to deal decisively with the related problem of the corporate debt. The current strategy is grounded in a decentralized, voluntary framework, essentially along the lines of the London Approach. Nevertheless, in all cases, there is some government involvement in debt workouts between the banks and corporations. Institutional and tax impediments to corporate debt restructuring have only recently been eliminated, with more liberal tax treatment extended to a wider range of debt restructuring transactions, creditors, and mergers and acquisitions; other institutional changes have also been made to facilitate debt-to-equity conversions. Perhaps, most important, is the strengthening of bankruptcy and foreclosure procedures, which could "bail in" the private sector by providing the necessary incentives for collective workouts and imposing discipline on the behavior of both debtors and creditors. Such procedures are only now falling into place through the introduction of more comprehensive legislation and reforms.
15. Another important aspect of corporate restructuring is to strengthen corporate governance -- that is to provide incentives for managers to act in ways that raise a firms' net present value and assure creditors and investors an adequate return. This has been done by improving transparency, accountability to shareholders, and developing capital markets.
Taking stock of progress
16. Let us take stock of what has been accomplished in IMF-supported programs. Currencies are rebounding and stabilizing. The Korean won, which late last year fell to a low of 2,000 to the dollar, has been trading at around 1,350 for an extended period; the Thai baht has appreciated by around 40 percent from its mid-January low of B 56 per dollar to almost B 40-41 per dollar. Even Indonesia, where the decline was steeper and lasted longer, has seen a pronounced appreciation since the depths of its crisis in mid-June.
17. The external position has strengthened decisively. External reserves, whose depletion, you will recall, marked the onset of the crisis, increased sharply. It is easy to forget that, just over 12 months ago, Thailand's net international reserves were barely positive: they have now risen to around $14 billion, and gross reserves are about twice that level -- more than 150 percent of Thailand's short-term debt. Korea's reserve restoration is even more impressive; gross international reserves have risen from only $7 billion at the end of last year, to more than $40 billion.
18. There has also been a very sharp turnaround in the current account, with surpluses in the range of 10-12 percent of GDP expected for Korea and Thailand this year. The main factor has been a steep fall in imports, but exports have also played a large part, and the improvement in the current account would have been greater if commodity prices had not fallen steeply, and demand from within the region, especially Japan, had not fallen off.
19. As I mentioned before, short-term interest rates are easing. In Korea and Thailand, short-term interest rates have declined relatively quickly and considerably.
20. Finally, by and large, the Asian countries have avoided the inflationary spirals that often accompany large currency depreciations. Particularly in Korea and Thailand, increases in inflation have fallen far short of expectations, and they are unlikely to represent an obstacle to resumed growth. In Indonesia, too, inflation is set to fall to modest levels in the next few months, with continued adherence to the IMF-supported program.
21. While these are all considerable achievements, it is nevertheless a matter of considerable concern to us that broader economic recovery is not yet at hand. Output in Korea and Thailand is expected to fall by around 7-8 percent this year, about double that in Indonesia, and many other countries in Asia are also experiencing economic declines. Unemployment is also rising markedly, resulting in social problems. Moreover, the global environment has deteriorated recently, raising renewed risks of contagion and instability in emerging markets.
Bringing about recovery
22. So, while the IMF-supported program has accomplished the stabilization objective, much more needs to be done to bring about economic recovery. While we do not know precisely how long this crisis will last, we do know that it will be over sooner if countries get on with their economic reforms and the international community provides financial support. This brings me to the preconditions for a return to sustainable growth. Dealing quickly and effectively with financial sector restructuring and putting corporate financial positions on sounder footing are essential to resume credit flows and support economic recovery.
23. More fundamentally, recovery and return to sustainable growth will require improvements in overall economic efficiency or productivity. For years, the Asian tigers' growth was mainly input-driven. Looking to the future, we can be quite certain that it is no longer possible to be "business as usual." Fortunately, many of the traditional "Asian values" will still be pluses: the dynamism, reverence for education, the skilled workforce, and the propensity to work and save. Nevertheless, capital may well be less abundant or more costly, so to restore growth to sustainable levels, investment will have to become more efficient.
Role of the international community
24. To support recovery and growth in Asia, the international community must also abandon "business as usual" and move to strengthen the architecture of the international financial system in order to minimize the risks of such crisis in the future. The task is to create a global system that is stable, sound, open, transparent, and fair. We at the IMF are working intensely, with other international fora and member governments, to achieve this objective as soon as possible.
25. The agenda for strengthening the architecture of the international financial system is a complex one indeed. It involves bringing together roles, rights, and obligations for the different constituents of the global economy: governments, citizens, private corporations, and international organizations. Let me just spend a few minutes to outline the work that is in progress at present in the IMF:
1. Deputy Director, Asia and Pacific Department, International Monetary Fund.