In the past few months, the evidence has been mounting that the worst of Asia’s crisis may be past. The cautious optimism at present stems from the actions that are being taken in Asia itself—in several well-known cases with IMF support—and from the measures taken by governments around the world to sustain economic activity and diminish the risk of global recession.
Background to the Crisis
The crises in east Asia were the result of interaction among flawed national financial systems, deficient corporate and public governance, and shortcomings in the global system. As global financial markets developed, especially in the early 1990s, capital was attracted to east Asia, in large part because of its exceptional reputation for growth and macroeconomic management. But the crises exposed serious structural weaknesses in these recipient countries that had been concealed by the magnitude of the flows, inadequate risk assessment by foreign creditors, and some weaknesses in supervisory practices in some creditor countries.
Another key factor was that the pace of de facto liberalization of short-term capital flows exceeded that of longer term flows, which encouraged domestic banks and corporations to accumulate large amounts of short-term external borrowing. As a result, the countries became highly vulnerable to sudden shifts in investor sentiment, an important factor in the striking speed and virulence with which the crisis spread through the region and threatened to extend worldwide.
Basic Strategy of IMF-Supported Programs
Since the countries faced an immediate liquidity crisis coupled with profound structural problems, the programs had to be comprehensive, embracing both structural and macroeconomic policies.
- Structural reform, particularly in the financial and corporate sectors, assumed a central role.
- Macroeconomic policies were used initially to stabilize the economy and later to support economic recovery. Monetary policy aimed to prevent a spiral of depreciation and inflation; once a measure of stability had returned to exchange markets, interest rates were allowed to decline. Fiscal policy sought to complement monetary policy and to make room in the budget for the costs of bank restructuring.
- Large official financing packages were seen as an essential complement to the policy programs to help break the cycle of capital outflows, exchange rate depreciation, and financial sector weakness.
The social dimensions of the programs were recognized from the start, but as the recession deepened, it became evident that the social consequences would be much greater than expected. In response, stronger measures were taken—for instance, to raise income transfers and to broaden the coverage of social safety nets. For the longer term, the challenge is to establish cost-effective, sustainable social programs that do not create harmful labor market disincentives or discourage job creation. The programs have featured close collaboration with the World Bank and the Asian Development Bank.
Performance and Prospects
Across Asia, the concern is to ensure that a new momentum is established for growth. The precise macroeconomic policies that are appropriate differ somewhat from country to country, but in almost every case there is need for decisive structural reform.
The programs with Indonesia, Korea, and Thailand were reviewed by the IMF’s Executive Board in December 1998. A review of the Philippines’ program was also completed earlier in the fourth quarter. Each program was on track and each country made purchases on schedule. Korea, the first country to have used the new Supplemental Reserve Facility, was able to make its first major repurchase [repayment] within a year of the onset of the crisis—important evidence that the programs are working.
The Board was impressed by the progress in stabilizing key financial variables, but was concerned at the depth of recession that the countries were experiencing. The slowdown was much sharper than assumed in formulating the programs, in part owing to the unanticipated deterioration in the external environment. Its magnitude prompted substantial revisions in economic policies. Now, with these policies beginning to take effect, the prospects are favorable for a return of growth during the course of 1999. Though the timing of the upturn is difficult to forecast precisely, it appears that growth has already started, at least in Korea. If confirmed, this will make the length of the recession comparable to that of Mexico after its crisis three years earlier.
The “other side of the coin” associated with the downturn and capital outflows was the large adjustment in current account balances, far exceeding original program projections. These adjustments—largely due to a sharp compression of imports—have permitted external reserves to rise sharply, underpinning the currency appreciation experienced by each of the crisis countries that has been so critical to restoring stability. Interest rates have declined, notably in Korea and Thailand, where they have returned to, or fallen below, precrisis levels.
Over the medium term, these economies clearly have the potential to resume a high growth path. Strong savings and improved productivity will play a key role in restoring sustainable growth. But deep structural problems remain, and the credibility of the programs requires that implementation of reforms should be accelerated further over the coming months.
Other Asian Countries
Recovery in the countries in crisis depends to a significant degree on the situation elsewhere in the region. Macroeconomic conditions across Asia differ appreciably, but most countries need to undertake significant reform to strengthen their economies for the long term.
Japan, as the world’s second largest industrial economy, has a key role to play in both regional and global terms. A prerequisite to reigniting sustained economic growth is the resolution of the problems in the banking system. The October 1998 legislation represents a significant step in this direction, establishing a broad framework that now needs to be applied effectively and transparently. But macroeconomic policies also have a major role to play in stimulating domestic demand. Recent policy measures—the announcement of major fiscal stimulus supported by monetary measures to boost liquidity growth—are clearly moves in the right direction. The critical challenge is to ensure that the recent initiatives are implemented in a manner that quickly provides the necessary stimulus to the economy.
Developments in China and Hong Kong SAR— notably the successful maintenance of the exchange rate regimes and the subsequent lowering of interest rates—have helped to restore stability in Asian financial markets. Fiscal policy is also providing helpful support to demand in both cases. While China’s growth is likely to slow this year and it faces many structural challenges, its economic performance continues to provide support for recovery elsewhere in the region.
India’s situation is rather different from those in East Asia, since it has experienced only a mild slowdown, an upturn in inflation, and a deteriorating trade balance. In these circumstances, the priorities are to address weakness in the fiscal position and to rein in the rapid rate of monetary expansion.
In Malaysia, economic activity remains weak, and the outlook for sustained recovery is uncertain. Although policy is becoming more expansionary, we are concerned about the implications for medium-term growth prospects of the imposition of capital and exchange controls as well as the relaxation of some prudential standards and the introduction of directed lending.
Characteristics of a Revitalized Asia
The Asian countries in crisis have the potential to return to rapid growth paths, even if the rates of growth are slightly lower than in the precrisis years. Since it is quite possible that the volume of investment will be smaller than in the past, rising growth rates will depend on gains in efficiency, which in turn hinge on the determined implementation of structural reforms. There are two main avenues for policymakers’ attention: to build on those features that were associated with east Asia’s remarkable reputation in the past and to give new emphasis to policies for sustained high quality growth.
By drawing on “traditional features,” policymakers can create an Asia that
- is open and competitive and continues to eschew protectionist policies;
- consolidates its record of sound macroeconomic policies;
- still maintains high rates of domestic saving; and
- invests efficiently and promotes technical progress through vigorous structural reform.
By assigning priority to policies for higher-quality growth, the economic leadership can also contribute to an Asia
- with sound financial systems, based on standards and practices that are consistent with internally accepted principles;
- that promotes an independent, competitive private sector with strong corporate governance;
- with high standards of public sector governance and transparency that maintains an arm’s-length relationship between the government and corporate sectors;
- that opens its capital markets through an orderly strategy accompanied by the strengthening of domestic financial systems; and
- that enhances social welfare and environmental protection.
Recent developments in Asia give further encouragement to the view that, eventually, the countries in crisis can return to high growth rates that can be reflected across the region. At present, it is possible to identify risks and constraints, particularly with regard to the external environment and the return of new capital inflows to the region, that make the precise pace and timing of the recovery a little uncertain. But our view—one that now seems to be shared by many outside the IMF—is that recovery will be under way by the end of 1999.
The Asian countries in crisis have the potential to return to rapid growth paths.