2. Issues in Currency Crisis Management
The Asian currency crises were not promptlybrought under control. Currencies continued to depreciate andthe crises spread to other countries even after agreements werereached on IMF programs. Do these facts point to fundamental defectsin existing crisis management capabilities after the start ofa currency crisis? Some criticism was also leveled against theterms of IMF conditionality.
(1) IMF Programs
When the international community providesfinancial support to rectify a drastic drop in the currency valueof an affected country, it is clearly necessary to require thecountry to accept an economic adjustment program. By the sametoken, it is quite natural under the current international monetarysystem for the IMF to play a leading role in formulating the adjustmentprogram. Reviewing the cases of the three Asian countries hitby the currency crises, it is notable that their agreements withthe IMF contained provisions for the implementation of structuralreforms, including the reform of their financial systems. Theseprovisions came in addition to the conventional terms of macroeconomicconditionality focusing on fiscal and monetary tightening.(seeAppendix 15, 16, and 17) However, in examining the progress ofthe crises, it is clear that the IMF agreements failed, at leastat the outset, to stop the continued depreciation of the affectedcurrencies.
The prolongation of the Asian currency crisesand the aspect of contagion to many countries engendered a levelof criticism against the international financial institutionsnever seen before. Regarding the terms of conditionality, criticismwas voiced against the degree of fiscal and monetary tighteningdemanded by the IMF. Similarly, questions were raised concerningthe appropriateness of the IMF intervention in structural issues.In particular, the IMF agreement with Indonesia which containednumerous terms addressing structural issues invited questionsand criticism. Issues of industrial structure and industrial policy,such as the presence of numerous monopolies and policies favoringspecific political forces, should certainly be rectified overthe long term. However, the question remains as to whether theseissues were of such urgency that they had to be addressed in themidst of a currency crisis. The attention of the market was directedtoward the resolution of structural issues because this was presentedas the central issue in re-establishing confidence. As a result,confidence in the rupiah was further eroded when it became clearthat the Indonesian government was not prepared to rectify quicklyits structural issues.
One of the points of contention involvesthe efficacy of conventional fiscal and monetary tightening incases where obvious macroeconomic imbalances do not exist. Itis argued that conventional tightening in such instances can actuallydeepen the crisis by worsening the underlying economic conditionsand eroding market confidence. This may be particularly true inAsia where, in contrast to the case of Latin America, economieshave traditionally been fiscally sound. Hence, increasing thefiscal surplus may not necessarily lead to a restoration of confidencein the case of Asia. The same types of doubts apply to monetarytightening. While monetary tightening may be necessary when acurrency is falling excessively, prolonged high interest ratescan be counterproductive when the financial sector is weak andcan lead to further erosion of confidence.
Another point of contention focuses on theterms of IMF conditionality applied to structural reform. Manyof the structural issues were previously identified by, for example,the World Bank, and there is no argument that measures shouldbe taken to rectify these issues. It has been argued that theIMF intervention has provided an opportunity for reforms whichotherwise would not have been implemented. From this perspective,the IMF was right in including provisions for structural reformin its agreements with the affected countries. The problem howeveris that many of these structural issues are deeply rooted in thepolitical, economic and cultural milieu of the country and requirea considerable period of time to be rectified. Additionally, thereis not much hope for rectification if the people of the countrydo not harbor a strong determination to go through with the necessaryreforms. In other instances, the order and timing of the reformprograms do not match domestic realities, as in the case of Indonesia,where the closing down of sixteen financial institutions lastyear without making proper provisions for the protection of depositorstriggered a massive run on the banks.
(Lesson)
While the failure of IMF agreements to immediately stabilize theaffected currencies cannot be completely attributed to the contentsof these agreements, a more flexible approach by the IMF in tailoringthe conditionalities to the situation in individual countrieswas desirable.
Particularly with regard to structural reform,a more flexible approach should have been taken so that the requirementsof a long-term agenda for reform can be differentiated from theurgent issues related to an ongoing liquidity crisis.
(2) Financial Support Schemes
The Asian currency crises required massiveamounts of financial support to match the massive capital outflowswhich had occurred. In the case of Thailand and Indonesia, theIMF authorized financial support packages equivalent to roughlyfive times their quotas. For South Korea, the total fund providedwas roughly 19 times the size of the South Korean quota. To providethis level of support, the IMF used the newly created the SupplementalReserve Facility (SRF, see Appendix 18) which is not subject toaccess limits.
Notwithstanding these unprecedented levelsof support, the IMF was unable to meet all the funding requirementsof the affected countries. Thus, it was necessary for Japan, theUnited States and other Asian countries to supplement the financialsupport provided by the IMF(see Appendix 19).
(Lesson)
Under the present international monetary system, there is no doubtthat the IMF must play a central role in providing financial supportto a country experiencing a currency crisis. However, it has beenshown that the current international framework featuring the IMFand other international financial institutions is not capableof mustering the huge financial resources required to counterthe massive transfer of funds which occur in a crisis in capitalaccounts. Thus, there is now an essential need to create an internationalframework for cooperation involving advanced economies and membersof the affected region to complement the efforts of the IMF.
At the same time, insofar as the IMF mustcontinue to play a principal role in these undertakings, it isof urgent importance for the IMF to bolster its capital resourcesto be able to effectively provide the large amounts of funds requiredin the rescue operations of the new type of currency crisis thatthreatens the global economy.
The World Bank, the Asian Development Bankand other multilateral development banks must now consider theformulation of new types of assistance schemes and formats inorder to address the two separate challenges of supporting medium-to long-term structural reform and providing necessary liquidityin currency crises of the recent Asian type.
(3) Private-Sector Burden Sharing
Private-sector claims and liabilities playeda central role in the Asian currency crises and posed the mostpressing problems. The use of public funds by domestic governments,international organizations and foreign governments to assistprivate-sector debtors gives rise to risk of moral hazard amongdebtors. It has been argued that in order to avert this moralhazard, the private sector (including both lenders and borrowers)should share some burden in resolving a crisis. However, due attentionmust be paid in cases where the debtors are banks and not non-bankprivate corporations because direct pressure on banks may triggersystemic risks with severe negative impacts on the domestic economy.
Private-sector burden sharing is not withoutits problems. Case-by-case settlement between private-sector debtorsand creditors can be very time consuming. There is a risk thatsuch delays will exacerbate a currency crisis.
(Lesson)
Due consideration must be given to the possibility of interventionby international organizations as moderators in the settlementof private-sector debts. Similarly, due prior consideration mustbe given to establishing a general set of rules for the disposalof private-sector debts.
(4) Assistance to the Export SectorHolds the Key to Recovery
As a result of the currency crises, manyAsian exporters have experienced a serious deterioration in theirfunding positions. This is because the financial institutionson whom Asian companies in general are highly dependent for theirfinancing needs have been enfeebled by the turmoil in the currencyand financial markets. Local financial institutions have losttheir international standing and in many cases are unable to issueletters of credit. This situation is hampering the importationof raw materials, intermediate goods and capital goods by theaffected countries. In response to these growing difficultiesin Thailand and Indonesia, various countries including Japan,the advanced countries and countries of the Asian region haveannounced that they will provide financial assistance to normalizetrade financing.
(Lesson)
The contraction of trade financing hampers the export sector whichmust play a key role in the economic recovery of affected countries.Thus, there is a need to consider how trade financing can be supplemented.
(5) Social Safety Net
Economic stagnation is an inevitable by-productof turmoil in the currency and financial markets and the subsequenteconomic adjustment polices. Economic stagnation and increasedunemployment leaves the strongest negative impact on vulnerablegroups. Thus, the IMF's economic adjustment programs for Thailand,Indonesia and South Korea were modified with an awareness of theimportance of making provisions for social safety nets. A measureof flexibility was injected into these program to provide roomfor humanitarian expenditures. (These include expansion of unemploymentinsurance and added subsidies for food and fuel.) The creationof social safety nets is of vital importance in helping vulnerablegroups who are directly affected by a currency crisis.
(Lesson)
Domestic governments, as well as international organizations involvedin assistance programs, must provide various types of financingwhich are oriented to the needs of vulnerable groups, and in thisway, take an active part in resolving structural issues relatedto poverty.