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From: International Monetary Fund, The Asia Crisis
Date: 4/24/99
Time: 10:37:34 AM
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Economic Crisis and Recovery in Asia and its Implications 1 for the International Financial System by Shigemitsu Sugisaki Deputy Managing Director of the International Monetary Fund at the Meeting on Development Cooperation: Responding to the Asia Crisis Sydney, Australia, March 5, 1999

I. Introduction

The economic record of East Asia over the past three decades is impressive by any measure. As a result of policies favoring outward-oriented growth, high savings and investment, and sound fiscal positions, per capita incomes in the region are, on average, 10 times higher than 30 years ago. Rapid growth has been the basis for equally impressive improvements in social indicators: reductions in poverty, increased investment in human capital, improved health care, and lower incidence of disease. Since the 1960s, life expectancy in the region has risen, on average, from 60 years to 70 years. Recent events aside, the socio-economic performance of the region has been called a "miracle," and rightly so.

Against this backdrop, the scale of the crisis in East Asia took most observers, the IMF included, by surprise. The severity of the crisis and the difficulties of the recovery process raise many important questions. I would like to focus on three of these:

First, are the Asian authorities’ reform efforts working? That is, are the economic policies adopted by governments, in many cases with the IMF’s financial support, appropriate and turning the economies around?

Second, how have the crisis and the IMF-supported programs affected the poor? Given the crucial importance of preserving the social gains in East Asia, are the policies containing the social costs of the crisis?

And finally, where do we go from here? Looking beyond the present crisis, what lessons have we learned about how to prevent future crises and, when they occur, how to deal with them? II. Basic Strategy of IMF-Supported Programs

As a broad generalization, the crisis in Asia was the result of the interaction among fundamental structural problems, in a few cases macroeconomic imbalances, and shortcomings in the international financial system. What made the crisis so different from previous ones and so difficult to tackle once it started were the financial vulnerabilities in the banking and corporate sectors, and the speed and size of capital flow reversals that occurred once those vulnerabilities were revealed. The buildup of these problems reflected deep-seated weaknesses in corporate governance; ineffective bank supervision; nontransparent relationships among government, banks and corporations; and macroeconomic imbalances evidenced by rising current account deficits and short-term external debt. And the counterpart of this buildup of financial vulnerabilities was considerable deficiency in creditors’ risk assessment.

Given the nature of the crisis, and the need to restore confidence as soon as possible, the basic strategy of the IMF-supported programs has had three elements:

to tighten macroeconomic policies in the initial stage in order to stabilize exchange rates, and stop capital flight, and inflation;

to mobilize large-scale external assistance from multilateral and bilateral sources, to help break the vicious cycle of capital outflows, currency depreciation, and deterioration in the financial sector; and

to tackle the key structural problems (mainly in the financial sector), to address the root cause of the crisis. As with all IMF-supported reform programs, these programs were flexible and adapted as circumstances changed. In particular, with recessions in these economies turning much deeper than initially expected, the adaptations in the IMF-supported programs included:

fiscal policy became more expansionary as growth slowed and current accounts strengthened;

structural reforms were broadened, mainly by focusing more directly on corporate sector restructuring as a key condition for rehabilitating banks and restoring growth; and

the focus on social safety nets was sharpened to contain the effects of the downturn on the most vulnerable parts of society. The IMF recently concluded a preliminary review of the programs in three Asian crisis countries: Thailand, Indonesia and Korea. Our conclusions were that, despite occasionalsetbacks, the basic strategy was sound and is working: financial stability has been restored; a recovery is imminent or already under way in all crisis countries; and a good start has been made with structural reforms.

By the same token, much remains to be done to restore East Asian growth to its potential. A clear lesson from the crisis is that when growth is accompanied by asset price bubbles, excessive and inefficient investment, and implicit public guarantees, the foundation for sustained growth is shaky. Hence, a revitalized East Asia will require a sound financial system, an independent and competitive private sector, and high standards of public sector governance. While a good start has been made, there is still much to be done in each of these areas.

III. Social Dimensions of the Asian Crisis

The IMF has long recognized that the programs it supports have far-reaching consequences in the economies and societies of its members, and that the IMF has an obligation to ensure that adverse social consequences are minimized. Thus, securing macroeconomic stability including containing inflation is fundamental to reducing the costs of the crisis on the poor. The IMF-supported programs during the Asian crisis also included a number of other measures to contain the social costs of the crisis; these measures were strengthened during the course of the program as it became apparent that the economic downturn was going to be deeper than initially expected.

Broadly speaking, the strategy was to include measures to provide income support for the unemployed, to raise targeted income transfers, and to broaden the coverage of social safety nets, which were often rudimentary. Fiscal policy was adapted to accommodate increased social expenditure. In implementing this strategy—in close collaboration with the World Bank and the Asian Development Bank—program design took account of the particular social problems each country faces. For instance:

In Indonesia, subsidies on food, fuel, electricity, medicine, and other essential items have been modified to ensure effective targeting of benefits to the poor. In particular, the program of targeted rice subsidies has contributed to stabilization of the price of rice in the country (after a period of severe price increases). The program also included employment-generating public works directed toward poor households, programs to help children from low-income families remain in school, and credit programs targeted to farmers and small- and medium-sized enterprises.

In Korea, unemployment insurance coverage has been extended, in several stages, to workers in small firms, as well as to part-time and temporary workers. The allocations for social assistance and special loan programs for the unemployed have been increased, temporary income support for the unemployed has been introduced, and public works programs expanded significantly.

In Thailand, temporary labor-intensive civil works programs in construction and infrastructure rehabilitation and job training programs have been introduced, and social spending and educational loan programs have been increased. Implementing these policies has not been easy. Monitoring the social impact of the crisis on different parts of the population, designing well-targeted social programs, and implementing them under conditions of economic instability and a severe recession has been difficult. A particular challenge has been to formulate a relatively simple, cost-effective, and sustainable social programs that do not create large labor market disincentives or discourage job creation. Timely mobilization of external financing is also critical to allow for increased social expenditures and the provision of adequate social safety nets.

While these programs have certainly helped to mitigate the social costs of the crisis, the sharp downturn in economic activity is clearly having serious adverse effects on the poor.

Unemployment and underemployment: in Thailand, unemployment has increased by about half since the start of the crisis, while unemployment in Korea reached 7.9 percent in December 1998. In Indonesia, formal sector employment has fallen sharply, with workers shifting to self-employment in the informal sector and returning to the rural economy.

Basic social services: private and public health care resources have declined, at least in foreign currency terms; and budget constraints have put some programmed improvements in health care at risk. At the same time, there has been a shift in demand from private health services to basic public health facilities, exacerbating the burden on the latter. Private drug companies have been facing economic difficulties because of high interest rates and import costs.

Education: evidence suggests that the school dropout rate has increased since the beginning of the crisis.

The social impact has been uneven across sectors and occupations: the urban populations seem to have been hit the hardest, while changes in relative prices have protected rural populations in some cases, especially food producers. Without attempting to minimize the impact of these costs, indications are that the social impact of the crisis may be less drastic than initially feared. This appears to be the message, for instance, of some of the evidence presented at a recent World Bank Regional Conference on Social Issues in Bangkok. While it is too early to reach definitive conclusions, there is reason to hope that while the social gains achieved during the decades of fast growth in East Asia have suffered a setback, the original gains remain largely intact.

The recent experience with social programs in Asia has served to highlight some basic policy imperatives to strengthen the prospects for equitable growth:

Countries need to strengthen their capacity to monitor, on a timely basis, the situation of the poor, including in the informal sector. Without a capacity for such monitoring, countries risk devoting inadequate resources to safety net policies that are not targeted to those most in need.

Policies for economic growth need to be complemented by cost-effective social protection programs. Developing these programs requires care to avoid labor market distortions (such as unduly generous unemployment benefits) that would hamper growth. There is also a need to make sure that the benefits of these programs do reach the grassroots level, and do not get lost in bureaucratic inefficiencies and corruption.

Governments need to work continually on increasing the benefits to lower income groups from social expenditures: This can be achieved by focusing more on basic health and education expenditures.

Adjustment programs must take great care to incorporate measures to protect the most vulnerable. IV. Implications for the International Financial System

The IMF is pleased that significant progress is being made in dealing with the crisis: Asia has stabilized and is turning toward recovery, and contagion from the recent crisis in Brazil has been relatively contained. Nonetheless, there is no denying that we live in a new world where globalized financial markets offer tremendous opportunities but also pose the risk of disruptive capital flow reversals. Work is under way, inside and outside the IMF, to adapt the international financial system to the realities of global markets, in order to reduce the frequency and size of future crises and to mitigate the impact on the most vulnerable when one occurs.

For individual countries, crisis prevention in the new global market requires an uncompromising effort to avoid the build-up of imbalances and disruptive capital flows and to make domestic systems more robust in the face of shocks. In turn, this requires not only appropriate macroeconomic policies, but also close attention to structural and social issues. Individual countries’ efforts are essential, but the current crisis has demonstrated the need for significant systemic improvements, that is, improvements in the "architecture" of the international financial system. The goal is to adapt the current system to the new realities of the global financial marketplace, by focusing on five main areas: development of internationally accepted standards; increased transparency; orderly integration of international financial markets; involvement of the private sector in the prevention and resolution offinancial crises; and adding a "social building block" to the edifice of the new international architecture.

The development, dissemination, and adoption of internationally accepted standards or codes of good practice contributes to a stronger financial architecture by allowing market participants to compare information on country practices against internationally agreed benchmarks of good practice and to make more sound investment decisions. The IMF's role here is both to help develop or refine standards in its core areas of expertise (data dissemination, monetary and financial policies, and fiscal transparency), and more generally to assist in the dissemination of standards and to encourage members to adopt them.

Transparency on the part of individual countries provides a means to foster better economic performance, in part by encouraging more widespread discussion and analysis of a country’s policies. Transparency on the part of the IMF (greater openness and clarity on our policies and advice) can also contribute to a better understanding of our role and operations and of our views on the policies of member countries.

Integrated international capital markets bring substantial benefits, but carry risks and need to be managed carefully. Consequently, with respect to capital account liberalization, the emphasis should be on an orderly and well-sequenced liberalization process, especially the prior need for a sound banking system. Effective international coordination and supervision of such liberalization is at the heart of ongoing efforts to enhance the IMF’s role in this area.

The international community is examining measures that can involve the private sector more systematically in preventing and resolving financial crises. This is one of the most difficult and complex issues being considered in the continuing discussions of the new financial architecture, and a consensus has yet to emerge. Moral hazard issues are at the forefront of this debate, and the challenge is not to protect unduly risky investor behavior or inappropriate government policies, while ensuring that new crisis management mechanisms do not drive investors away as soon as a crisis looms.

Finally, the new architecture could well include a "social building block" which would seek an international commitment to appropriate social safety nets, core labor standards, consensus-building in countries, and common social goals.

The task of redesigning the architecture is challenging. While progress is being made, there is much to be done, and an internationally coordinated and sustained effort is needed to complete the task. The IMF will continue to be a focal point of the policy debate, coordination, and implementation, but the major contribution must come from member countries and other international organizations. The IMF will play its part with the support of the membership.

1 Presented at the Meeting on Development Cooperation: Responding to the Asia Crisis, Sydney, Australia (March 5, 1999).

Last changed: March 17, 2000