Some suggested this could lead to the collapse of the only support left for domestic currencies, namely the huge trade surpluses that were being generated as a result of that collapse in demand which had in turn led to sharply lower imports. Others attributed this to year-on-year basing effects, dismissing any prospect of recovery in the near term and pointing instead to the protracted downturn in Latin America, Mexico and Japan after their respective financial crises in 1982, 1995 and 1991. Yet, to us, this slowdown in the pace of import contraction represented something quite different, the first, faint flickering of recovery. In medical terms, it would have been the first up-beat on a heart monitor which had been flat-lining, faint, but still there. Proof at least that the patient was not going to die.
Demand remained deeply depressed by standard consumption indicators, unemployment continued to rise and economies for the most part continued to contract on a quarterly basis. These were, however, lagging indicators, for the most part reflective of the past, substantial inventory reduction and corporate downsizing. Some were sceptical of the reasons behind a gathering slowdown in the pace of import contraction in the likes of Thailand and Korea in particular, attributing the move the to J-curve effects whereby the devaluation of local currencies exaggerated the dollar value of imported goods. Yet, this slowdown in import contraction appeared to be also happening in volume as well as value terms, seriously questioning such a view. For the full year of 1998, imports contracted by a stunning 35.5 year-on-year in Korea and by almost 340o in Thailand after a 13.4% contraction in 1997, yet the first sign of improvement in this key indicator was seen in the fourth quarter of that year. If the collapse in imports was slowing down, that meant that at the very least the fall in demand was slowing, positive news in a regional environment where all prevailing news was dire to moderately bad. That first sign of stabilisation in the IMF programme-countries such as Thailand and Korea were matched by the more efficient economies such as Singapore, which saw a GDP contraction in the fourth quarter of 1998 of -1.1% as against a contraction of -1.9 in the third quarter. While the feeling on the streets was one of utter misery as the full unemployment effects of the financial and economic crisis continued to be felt, particularly by those who had started off lower down on the ladder in any case, a gradual reduction in financial market pessimism took place in the final months of 1998 and the first quarter of 1999 as regards Asian economic prospects. Singapore actually saw positive growth in the first quarter of 1999 of +O.6 and other ASEAN countries saw their contractions continue to shrink. Suddenly, there was talk that since Thailand had been first into the Asian crisis, it would be the first out. Thai manufacturing production had clearly bottomed in May of 1998 (at a contraction rate of around - 1 5 year-on-year), however this was rightly attributed initially to Thai companies re-directing production towards export markets which were still buoyant, as well as basing effects from the financial and economic collapse in 1997. By February of 1999, however, the Thai manufacturing production was actually in positive territory on a year- on-year basis, a degree of revival which could not simply be explained by exports, particularly as exports were still falling (they fell 4 year-on-year in the first quarter of 1999). Simultaneous to that, albeit after a lag, imports started to come back in earnest. After falling 11.6 in the fourth quarter of 1998, import growth in volume terms (and thus not distorted by foreign exchange considerations) actually rose over 5 in the first two months of 1999. Simultaneous to this process, the collapse in credit growth bottomed out and money supply growth data also regained positive territory in early 1999, the result of the massive fiscal and monetary stimulus which the Thai and other ASEAN governments undertook from the second half of 1998 onwards.
วันอังคารที่ 3 สิงหาคม พ.ศ. 2553
CHAPTER 3 THE RECOVERY - SET TO CONTINUE?
If 1998 was a year of excruciating pain for most Asian economies - which undoubtedly it was - then 1999 has been altogether a different story, one which has repeatedly and publicly been dubbed the year of Asian recovery by the world’s media. Even those Asian economists who were reluctant to forecast a supposed “V-shaped” recovery from that dire year of 1998 were gradually forced to admit gathering signs of economic expansion. From early 1999, it looked as if we could see a revival due to the Keynes-ianist policies adopted in the wake of the IMF’s policy U-turn of allowing significant monetary and fiscal easing.
In truth, the first signs had appeared in the last quarter of 1998. In Fhailand and Korea, where the crisis had begun, exports had collapsed and imports were continuing to contract by some 3000 year- over-year through the end of the third quarter reflecting an equal collapse in domestic demand. In Indonesia, domestic prices were still rising, but elsewhere they were falling, further confirmation of that slide in demand. However, in the fourth quarter of 1998, we started to see a marked reduction in the year/year contraction of imports in Thailand, Korea, the Philippines and even Indonesia. If the first sign of financial market stabilisation was the collapse of imports and the consequent, dramatic turnaround in national trade accounts, the first sign of economic stabilisation was paradoxically almost the complete opposite, that is the slowdown in import contraction if not the actual revival in imports.
In truth, the first signs had appeared in the last quarter of 1998. In Fhailand and Korea, where the crisis had begun, exports had collapsed and imports were continuing to contract by some 3000 year- over-year through the end of the third quarter reflecting an equal collapse in domestic demand. In Indonesia, domestic prices were still rising, but elsewhere they were falling, further confirmation of that slide in demand. However, in the fourth quarter of 1998, we started to see a marked reduction in the year/year contraction of imports in Thailand, Korea, the Philippines and even Indonesia. If the first sign of financial market stabilisation was the collapse of imports and the consequent, dramatic turnaround in national trade accounts, the first sign of economic stabilisation was paradoxically almost the complete opposite, that is the slowdown in import contraction if not the actual revival in imports.
TINKERING WITH THE MICRO-ECONOMY
The last strategy response from the Asian countries which we will look at briefly - and subsequently in a later chapter in substantially more detail - is that of microeconomic reform and restructuring. In contrast to the Latin American debt crisis of 1995 which undoubtedly had major microeconomic effects, but whose roots were macroeconomic, the very root cause of the Asian crisis lay in the micro-economy. Consequently, a key strategy for dealing with the worst effects of the crisis and for reviving Asia’s shattered and bruised economies had to deal with microeconomic management and reform. Here, one has to say that the record in 199 7-98, while fine in theory, was poor in practice, in the implementation of that theory.
Some progress was made however. Since the onset of the Asian crisis, several Asian countries have sought to improve their regulatory frameworks for domestic financial institutions, forcing increases in bank CAR ratios and the improvement of standards on loan provisioning and loan classification.
In addition, the governments of Korea, Indonesia and Thailand sought to varying degrees to put in place an institutional and legal framework for the resolution of debt restructuring. Finally, all three countries increased foreign investor access to their markets, companies and banks through the raising of foreign investor ownership ceilings and the reduction or elimination of rules inhibiting such access. Korea, for example, fully liberalised foreign purchases of domestic Korean won bonds and abolished most ownership restrictions for foreign investors, key elements in the task of re-liquifying the Korean financial and economic system. In the financial sector, to recall, Thailand closed 56 finance companies, while Korea closed more than half of its merchant banks. In addition, it closed two commercial banks, re-capitalised them and sought to resell them to domestic and foreign investors. The governments of Korea and Thailand announced the issuance of domestic bonds worth up to 15 of the GDP, placing these with domestic financial institutions in order to put a floor under the balance sheet of their respective banking systems.
All sound measures and proof indicated that the efforts of the IMF and World Bank were not wasted and that progress was made at the micro-economic as well as the macroeconomic level. That said, one should not under-estimate the damage caused at the micro-economic level by the crisis and thus the remaining problem. The World Bank in its report East Asia: The Road to Recovery’, said that it was estimated that as a result of the crisis two-thirds of Indonesian firms suffered losses exceeding their equity, while for Korea this figure was two-fifths and for Thailand one quarter.5 Higher interest rates, plunging capital bases, a collapse in available domestic bank credit as banking systems sought first to repair their own balance sheets combined to produce a ruinous result for many Asian corporations. In the go-go days of Asian economic growth, the fundamental weaknesses of many of these companies, including small capital and equity bases and over-leverage on cheap, in many cases governmentinduced credit, had been hidden by strong top line growth in the P&L. Diminishing total returns was a warning prior to the crisis, a warning
which went unheeded at all levels.
High debt-equity ratios was however the natural product of the Asian growth model, itself founded on consensus and co-operative rather than competitive economics. Asian governments had sought to expand deliberately the strategic export sectors. In order to do so, they provided, directly or through their banking systems, cheap, directed credit, subsidised loans and tax breaks. Insufficiently deep Asian equity and bond markets required that the Asian corporates rely for most of their external funding on bank loans. In the early 1990s, many Asian governments removed or reduced borrowing limits, particularly on foreign currency borrowing, but failed simultaneously to strengthen banking, corporate regulation and supervision. When I arrived in Asia at the start of 1996, before I joined the banking sector, many of its markets and economies felt like a Gold rush precisely because there was insufficient control or supervision of bank lending or corporate borrowing. It was the ‘Wild East” in that just about anything went. Cheap credit was available and deals were done whatever it took. Corporate governance played a part also in that corporate borrowing was in many cases hugely excessive relative to its potential for driving the bottom line. As a result, a substantial part of corporate profit went into paying interest costs, thus making corporations especially vulnerable to domestic interest rate rises. For example, by 1997, according to the World Bank, more than two thirds of all profits of listed Thai companies went to cover the interest costs.
In addition, excessively cosy relationships between domestic bank loan officers and many corporations led to increased loans to firms with high debt leverage and low profitability. Political pressure from the top to make loans to favoured or strategic companies had an eventual cost and in 1997 and 1998 that cost was high - and remains high to this day. As stated in Asia Falling, it is all about incentive. Banks had little incentive for ensuring that their loans were creditworthy, while corporations had little incentive to ensure that their loans were needed in the first place since they would get them anyway. The market pricing mechanism was thus significantly distorted. What we have seen subsequently is not only the result of that but effectively an attempt by “the market” to achieve a greater degree of pricing mechanism equilibrium. In the 1960s and 1970s, many Asian countries privatised banks and corporations, however in many cases they retained a heavy hand in their financial running. As an economist, it is my profound view that the state is inherently inefficient from a profit perspective in running companies and banks, a condition brought about by the fact that profit is not the only or in some cases even the major motive. Interlocking relationships between the government, banks and corporations thus reduced the ability of the market mechanism to function, thus inexorably leading to ever diminishing returns and the consequent need for ever increasing credit just to maintain those returns. Cronyism” was a factor behind the Asian crisis. To anyone with any common sense, this is merely stating the obvious, but to some apparently it has to be said. Granted, that same cronyism or contact- or consensus- capitalism depending on how one terms it was also a key plank of the Asian growth story for at least two decades, but such practices, lacking the discipline of a free market which focuses only on the bottom line eventually led to major price distortion, such distortions inevitably being corrected, albeit after a substantial period of time and at the expense of a regional crash.
Inadequate domestic asset markets and more specifically the infrastructure of those asset markets, namely zealous and INDEPENDENT regulators and deep and broad institutional investor bases were also a key reason for the lack of true market discipline which pervaded in Asia in the 1990s. For instance, in 1996, the mutual fund industry represented under 1000 of the total Stock Exchange of Thailand (SET) trading. Outside of Singapore, many Asian countries had weak or minimal pension fund industries. Finally, the very organisational structure had a part to play in the eventual Asian crisis, characterised most commonly by a diversified conglomerate structure whose shares were closely held by a family. Given the lack of development of the Asian equity markets and the lack of minority shareholder rights, these owners again did not have sufficient incentive to make their corporations efficient. They simply did not have to.
The result of all this was that the crisis caused wholesale bankruptcy in countries which had these fundamental microeconomic flaws. Indonesia was easily the hardest hit, followed by Korea and Thailand. The extent of the damage reached systemic proportions in all IMF programme member countries. Solving this crisis at the microeconomic level always necessitated a comprehensive and cooperative strategy involving international creditors, domestic banks and corporations, domestic governments and the influence of multilateral organisations to prod proceedings along in the right direction. Using the incentive rule, such strategies oniy work if they have to, if they are forced to. This implies the breaking up of those cosy relationships between banks, corporations and governments. There is a key lesson from the Japan crisis (1991-and still counting) in this. Bank restructuring in particular works most effectively if it is enforced by the government, creditors or shareholders, rather than at the agreement of cosy agreements. This was a key reason why the Japanese government attempts at bank restructuring - however belated, however pitiful - have so far failed to achieve what most in the West see as the desired result - a profitable, healthy bank. Instead of this, Japan has gradually been nationalising its financial system, a strategy which is doomed to ever diminishing returns and ultimate failure. When faced with the painful choice between propping up institutions (and those cosy relationships) or biting the bullet and letting such institutions go or be forcibly restructured, no matter what the short term cost to prices or market confidence, Japan chose the easy way out.
It has yet to be confirmed that Thailand, Korea and Indonesia have avoided this route. If they have not, that will have dire consequences for the medium- and long-term growth prospects of their economies. The alternative to the approach of bank-led restructuring is theoretically and has been practically that of government-led restructuring. Under this model, the government creates an asset management company to reduce and restructure bank non- performing loans, taking over and restructuring bad debts and replacing these assets with bond issues, thus the banking system is re-capitalised. While governments may prefer voluntary negotiations between bank creditors and corporate debtors, without appropriate balancing mechanisms in order to avoid social structure damage, this is rarely the most appropriate way of achieving an efficient result. What seems clear is that there must be an element of enforceability of this restructuring by the authorities and equally a degree of submission to market pricing discipline. On the latter, this means, whatever price the market currently supports is the price you get for your distressed assets, not the price you or your government might want. However, those distressed assets need domestic as well as foreign buyers. More has to be done to democratise the Asian equity markets, increasing the rights of minority shareholders, developing strong mutual and pension fund industries which in turn can help enforce corporate and bank restructuring - or throw out directors and CEOs through the creation of emergency shareholder meetings - a source of much humour in Japan for some time and look at the cost of that. Disclosure and accounting standards have to be improved (or in some cases created). Remember, things don’t improve if they don’t have to improve. The message to Asia is a clear, if an uncomfortable one: the Asian capitalist model does not work anymore. It has passed its sell by date. This is not to say that Asia should necessarily and automatically adopt a U.S. version. It is to say that Asian governments and financial authorities should create true market places, which might or might not mimic their U.S. counterparts, but which focus on creating free and fair trade, strong regulatory and supervisory standards and the institutional investor structure to support deep and liquid asset markets. The pricing mechanism used must be the market rather than the relationship. Why? Not because that is the U.S. model (it is questionable whether or not it is in fact given trade subsidies which both the U.S. and Europe provide), but because it is the most efficient model, providing the soundest base for long-term sustainable growth. That, surely, must be the aim.
The emphasis on the market pricing mechanism must not be at the expense of ignoring the importance of creating a sufficient legal framework, a crucial element in any country’s infrastructure, as important as ports and roads, as electricity, housing and education. In the case of a debt and currency crisis, the first priority in this regard must be to provide an adequate bankruptcy law framework to encourage new investors to pick through the rubble of distressed assets. Only when this occurs will there be sufficient incentive not to become distressed in the first place. In the wake of what appears to be strong recoveries in Asia, this may no longer seem relevant, but it most assuredly is. Without sufficient microeconomic reform and restructuring, those recoveries will most assuredly prove fleeting, the result of temporary fiscal and monetary stimulus which when removed in order to avoid renewed inflation results in a sharp pullback in domestic demand. Generally speaking, there are three types of resolving bankruptcy or insolvency: liquidation, rescue or agreed restructuring or “work out” involving informal relationships outside of the court’s mandate. Both liquidation and rescue necessitate the presence and active involvement of the formal court procedure, the first leading most likely to a sale of assets to a third party (the company and the court being the first two parties), the second involving the administered rescue of a company as a viable and going concern through public infusion or in the private sector case most likely debt-equity swaps. The dependency in Thailand, Korea and Indonesia on the Asian model of consensus rather than market capitalism led to an initial emphasis on informal work outs after the crisis, despite the emphasis by the IMF on the strengthening of the institutional infrastructure framework. Issues such as “loss of face” and the necessity to maintain business and banking relationships have proved to be strong obstacles to the initial creation and then the enforcement of efficient bankruptcy laws. However, it is wrong to say that culture is an inevitable obstacle to this process. The Singapore bankruptcy code, shaped by the UK 1985 Insolvency Act is a case in point, involving supposed Western legal enforcement with an Asian emphasis on compromise and negotiation, a potential model for others in the region to follow. Extending that example, it is no coincidence whatsoever that Singapore has an exceptionally strong corporate legal framework and zealous and independent regulatory bodies, and at one and the same time its corporate and banking systems are relatively low geared - as befits PROFIT necessity - and have survived the Asian crisis for the most part healthy and intact. There are no doubt strong relationships between banks and corporations in Singapore, but they are not allowed to be the founding premise for debt creation.
Outside of Singapore, in crisis countries where the relationship became the essence of the pricing mechanism, rather than the market, is where the Asian model eventually broke down when it was forced to compete with the unfettered forces of the global freemarket system. The Asian model does not have to be scrapped wholesale, but the driving force and the incentive for economic growth have to be altered in favour of the market. Strong relationships can and should still exist. That need not change, but they cannot be the primary motivating force behind economic expansion. Not anymore. The alternative is to reject the global system and turn inwards, but that is not a realistic option for any but the foolhardy. The “emerged’ nations chose that alternative in the 1930s, in favour of trade and capital market protectionism. The Great depression was the result.
Going forward, Asia, now more than ever, will need access to great amounts of liquidity. In the short term it might get that from asset managers seeking short-term returns. However, to rely on those is to ignore many of the key lessons of the crisis, not least that over- reliance on short-term capital flows is a perilous policy choice - and that is exactly what is, a policy choice. There is an alternative, and that is to create a more viable platform for foreign direct investment in the cases of some, institutional infrastructure for others, recapitalising their financial systems not only with money but with the legal and supervisory framework to encourage investors to the view that the crisis will not re-occur.
So much for what has not happened at the level of microeconomic reform, what is needed, what is to come - or not. This is not to take anay from the fact that 1999 saw a dramatic recovery in Asian economies, one which surprised many. The length of that recovery will, as we have seen, depend crucially on the extent of microeconomic reforms which Asian countries attempt to achieve. That said, IF such reforms are imposed, it is a recovery which has some chance of continuing into 2001 and beyond, depending of course on how the external environment, not least in the U.S., pans out. The next chapter looks at this issue of Asian economic recovery, how it was created, the recovery’s first symptoms and why macroeconomic dynamics suggest it will continue at least in the short term.
Some progress was made however. Since the onset of the Asian crisis, several Asian countries have sought to improve their regulatory frameworks for domestic financial institutions, forcing increases in bank CAR ratios and the improvement of standards on loan provisioning and loan classification.
In addition, the governments of Korea, Indonesia and Thailand sought to varying degrees to put in place an institutional and legal framework for the resolution of debt restructuring. Finally, all three countries increased foreign investor access to their markets, companies and banks through the raising of foreign investor ownership ceilings and the reduction or elimination of rules inhibiting such access. Korea, for example, fully liberalised foreign purchases of domestic Korean won bonds and abolished most ownership restrictions for foreign investors, key elements in the task of re-liquifying the Korean financial and economic system. In the financial sector, to recall, Thailand closed 56 finance companies, while Korea closed more than half of its merchant banks. In addition, it closed two commercial banks, re-capitalised them and sought to resell them to domestic and foreign investors. The governments of Korea and Thailand announced the issuance of domestic bonds worth up to 15 of the GDP, placing these with domestic financial institutions in order to put a floor under the balance sheet of their respective banking systems.
All sound measures and proof indicated that the efforts of the IMF and World Bank were not wasted and that progress was made at the micro-economic as well as the macroeconomic level. That said, one should not under-estimate the damage caused at the micro-economic level by the crisis and thus the remaining problem. The World Bank in its report East Asia: The Road to Recovery’, said that it was estimated that as a result of the crisis two-thirds of Indonesian firms suffered losses exceeding their equity, while for Korea this figure was two-fifths and for Thailand one quarter.5 Higher interest rates, plunging capital bases, a collapse in available domestic bank credit as banking systems sought first to repair their own balance sheets combined to produce a ruinous result for many Asian corporations. In the go-go days of Asian economic growth, the fundamental weaknesses of many of these companies, including small capital and equity bases and over-leverage on cheap, in many cases governmentinduced credit, had been hidden by strong top line growth in the P&L. Diminishing total returns was a warning prior to the crisis, a warning
which went unheeded at all levels.
High debt-equity ratios was however the natural product of the Asian growth model, itself founded on consensus and co-operative rather than competitive economics. Asian governments had sought to expand deliberately the strategic export sectors. In order to do so, they provided, directly or through their banking systems, cheap, directed credit, subsidised loans and tax breaks. Insufficiently deep Asian equity and bond markets required that the Asian corporates rely for most of their external funding on bank loans. In the early 1990s, many Asian governments removed or reduced borrowing limits, particularly on foreign currency borrowing, but failed simultaneously to strengthen banking, corporate regulation and supervision. When I arrived in Asia at the start of 1996, before I joined the banking sector, many of its markets and economies felt like a Gold rush precisely because there was insufficient control or supervision of bank lending or corporate borrowing. It was the ‘Wild East” in that just about anything went. Cheap credit was available and deals were done whatever it took. Corporate governance played a part also in that corporate borrowing was in many cases hugely excessive relative to its potential for driving the bottom line. As a result, a substantial part of corporate profit went into paying interest costs, thus making corporations especially vulnerable to domestic interest rate rises. For example, by 1997, according to the World Bank, more than two thirds of all profits of listed Thai companies went to cover the interest costs.
In addition, excessively cosy relationships between domestic bank loan officers and many corporations led to increased loans to firms with high debt leverage and low profitability. Political pressure from the top to make loans to favoured or strategic companies had an eventual cost and in 1997 and 1998 that cost was high - and remains high to this day. As stated in Asia Falling, it is all about incentive. Banks had little incentive for ensuring that their loans were creditworthy, while corporations had little incentive to ensure that their loans were needed in the first place since they would get them anyway. The market pricing mechanism was thus significantly distorted. What we have seen subsequently is not only the result of that but effectively an attempt by “the market” to achieve a greater degree of pricing mechanism equilibrium. In the 1960s and 1970s, many Asian countries privatised banks and corporations, however in many cases they retained a heavy hand in their financial running. As an economist, it is my profound view that the state is inherently inefficient from a profit perspective in running companies and banks, a condition brought about by the fact that profit is not the only or in some cases even the major motive. Interlocking relationships between the government, banks and corporations thus reduced the ability of the market mechanism to function, thus inexorably leading to ever diminishing returns and the consequent need for ever increasing credit just to maintain those returns. Cronyism” was a factor behind the Asian crisis. To anyone with any common sense, this is merely stating the obvious, but to some apparently it has to be said. Granted, that same cronyism or contact- or consensus- capitalism depending on how one terms it was also a key plank of the Asian growth story for at least two decades, but such practices, lacking the discipline of a free market which focuses only on the bottom line eventually led to major price distortion, such distortions inevitably being corrected, albeit after a substantial period of time and at the expense of a regional crash.
Inadequate domestic asset markets and more specifically the infrastructure of those asset markets, namely zealous and INDEPENDENT regulators and deep and broad institutional investor bases were also a key reason for the lack of true market discipline which pervaded in Asia in the 1990s. For instance, in 1996, the mutual fund industry represented under 1000 of the total Stock Exchange of Thailand (SET) trading. Outside of Singapore, many Asian countries had weak or minimal pension fund industries. Finally, the very organisational structure had a part to play in the eventual Asian crisis, characterised most commonly by a diversified conglomerate structure whose shares were closely held by a family. Given the lack of development of the Asian equity markets and the lack of minority shareholder rights, these owners again did not have sufficient incentive to make their corporations efficient. They simply did not have to.
The result of all this was that the crisis caused wholesale bankruptcy in countries which had these fundamental microeconomic flaws. Indonesia was easily the hardest hit, followed by Korea and Thailand. The extent of the damage reached systemic proportions in all IMF programme member countries. Solving this crisis at the microeconomic level always necessitated a comprehensive and cooperative strategy involving international creditors, domestic banks and corporations, domestic governments and the influence of multilateral organisations to prod proceedings along in the right direction. Using the incentive rule, such strategies oniy work if they have to, if they are forced to. This implies the breaking up of those cosy relationships between banks, corporations and governments. There is a key lesson from the Japan crisis (1991-and still counting) in this. Bank restructuring in particular works most effectively if it is enforced by the government, creditors or shareholders, rather than at the agreement of cosy agreements. This was a key reason why the Japanese government attempts at bank restructuring - however belated, however pitiful - have so far failed to achieve what most in the West see as the desired result - a profitable, healthy bank. Instead of this, Japan has gradually been nationalising its financial system, a strategy which is doomed to ever diminishing returns and ultimate failure. When faced with the painful choice between propping up institutions (and those cosy relationships) or biting the bullet and letting such institutions go or be forcibly restructured, no matter what the short term cost to prices or market confidence, Japan chose the easy way out.
It has yet to be confirmed that Thailand, Korea and Indonesia have avoided this route. If they have not, that will have dire consequences for the medium- and long-term growth prospects of their economies. The alternative to the approach of bank-led restructuring is theoretically and has been practically that of government-led restructuring. Under this model, the government creates an asset management company to reduce and restructure bank non- performing loans, taking over and restructuring bad debts and replacing these assets with bond issues, thus the banking system is re-capitalised. While governments may prefer voluntary negotiations between bank creditors and corporate debtors, without appropriate balancing mechanisms in order to avoid social structure damage, this is rarely the most appropriate way of achieving an efficient result. What seems clear is that there must be an element of enforceability of this restructuring by the authorities and equally a degree of submission to market pricing discipline. On the latter, this means, whatever price the market currently supports is the price you get for your distressed assets, not the price you or your government might want. However, those distressed assets need domestic as well as foreign buyers. More has to be done to democratise the Asian equity markets, increasing the rights of minority shareholders, developing strong mutual and pension fund industries which in turn can help enforce corporate and bank restructuring - or throw out directors and CEOs through the creation of emergency shareholder meetings - a source of much humour in Japan for some time and look at the cost of that. Disclosure and accounting standards have to be improved (or in some cases created). Remember, things don’t improve if they don’t have to improve. The message to Asia is a clear, if an uncomfortable one: the Asian capitalist model does not work anymore. It has passed its sell by date. This is not to say that Asia should necessarily and automatically adopt a U.S. version. It is to say that Asian governments and financial authorities should create true market places, which might or might not mimic their U.S. counterparts, but which focus on creating free and fair trade, strong regulatory and supervisory standards and the institutional investor structure to support deep and liquid asset markets. The pricing mechanism used must be the market rather than the relationship. Why? Not because that is the U.S. model (it is questionable whether or not it is in fact given trade subsidies which both the U.S. and Europe provide), but because it is the most efficient model, providing the soundest base for long-term sustainable growth. That, surely, must be the aim.
The emphasis on the market pricing mechanism must not be at the expense of ignoring the importance of creating a sufficient legal framework, a crucial element in any country’s infrastructure, as important as ports and roads, as electricity, housing and education. In the case of a debt and currency crisis, the first priority in this regard must be to provide an adequate bankruptcy law framework to encourage new investors to pick through the rubble of distressed assets. Only when this occurs will there be sufficient incentive not to become distressed in the first place. In the wake of what appears to be strong recoveries in Asia, this may no longer seem relevant, but it most assuredly is. Without sufficient microeconomic reform and restructuring, those recoveries will most assuredly prove fleeting, the result of temporary fiscal and monetary stimulus which when removed in order to avoid renewed inflation results in a sharp pullback in domestic demand. Generally speaking, there are three types of resolving bankruptcy or insolvency: liquidation, rescue or agreed restructuring or “work out” involving informal relationships outside of the court’s mandate. Both liquidation and rescue necessitate the presence and active involvement of the formal court procedure, the first leading most likely to a sale of assets to a third party (the company and the court being the first two parties), the second involving the administered rescue of a company as a viable and going concern through public infusion or in the private sector case most likely debt-equity swaps. The dependency in Thailand, Korea and Indonesia on the Asian model of consensus rather than market capitalism led to an initial emphasis on informal work outs after the crisis, despite the emphasis by the IMF on the strengthening of the institutional infrastructure framework. Issues such as “loss of face” and the necessity to maintain business and banking relationships have proved to be strong obstacles to the initial creation and then the enforcement of efficient bankruptcy laws. However, it is wrong to say that culture is an inevitable obstacle to this process. The Singapore bankruptcy code, shaped by the UK 1985 Insolvency Act is a case in point, involving supposed Western legal enforcement with an Asian emphasis on compromise and negotiation, a potential model for others in the region to follow. Extending that example, it is no coincidence whatsoever that Singapore has an exceptionally strong corporate legal framework and zealous and independent regulatory bodies, and at one and the same time its corporate and banking systems are relatively low geared - as befits PROFIT necessity - and have survived the Asian crisis for the most part healthy and intact. There are no doubt strong relationships between banks and corporations in Singapore, but they are not allowed to be the founding premise for debt creation.
Outside of Singapore, in crisis countries where the relationship became the essence of the pricing mechanism, rather than the market, is where the Asian model eventually broke down when it was forced to compete with the unfettered forces of the global freemarket system. The Asian model does not have to be scrapped wholesale, but the driving force and the incentive for economic growth have to be altered in favour of the market. Strong relationships can and should still exist. That need not change, but they cannot be the primary motivating force behind economic expansion. Not anymore. The alternative is to reject the global system and turn inwards, but that is not a realistic option for any but the foolhardy. The “emerged’ nations chose that alternative in the 1930s, in favour of trade and capital market protectionism. The Great depression was the result.
Going forward, Asia, now more than ever, will need access to great amounts of liquidity. In the short term it might get that from asset managers seeking short-term returns. However, to rely on those is to ignore many of the key lessons of the crisis, not least that over- reliance on short-term capital flows is a perilous policy choice - and that is exactly what is, a policy choice. There is an alternative, and that is to create a more viable platform for foreign direct investment in the cases of some, institutional infrastructure for others, recapitalising their financial systems not only with money but with the legal and supervisory framework to encourage investors to the view that the crisis will not re-occur.
So much for what has not happened at the level of microeconomic reform, what is needed, what is to come - or not. This is not to take anay from the fact that 1999 saw a dramatic recovery in Asian economies, one which surprised many. The length of that recovery will, as we have seen, depend crucially on the extent of microeconomic reforms which Asian countries attempt to achieve. That said, IF such reforms are imposed, it is a recovery which has some chance of continuing into 2001 and beyond, depending of course on how the external environment, not least in the U.S., pans out. The next chapter looks at this issue of Asian economic recovery, how it was created, the recovery’s first symptoms and why macroeconomic dynamics suggest it will continue at least in the short term.
HONG KONG
While other Asian currencies were allowed to depreciate, to whatever degree, Hong Kong did not have that luxury, having adopted a currency board in October 1983 when the peg - for want of a better word, since it is not strictly speaking a currency “peg” - was fixed at
7.80 Hong Kong dollars to the U.S. dollar. What the Hong Kong authorities themselves call a linked exchange rate regime (i.e, a currency board) is designed to allow Hong Kong interest rates to adjust automatically to currency pressures via changes in domestic money supply, whereby the selling of Hong Kong dollars results in an equal reduction in the Hong Kong dollar money supply, thus causing interest rates to rise. Eventually, as the logic of the currency board system goes, domestic Hong Kong interest rates reach a level which attracts renewed investor interest in the Hong Kong dollar, causing purchases of that currency and subsequently an equal and opposite increase in the supply of Hong Kong dollars to the system, thus causing interest rates to fall back once more. In theory, the system is beautifully and elegantly simple. However, the practice of financial markets can be somewhat more violent. The date of October 23, 1997 was the first of several to be etched in the minds of those who watched the Hong Kong markets during the crisis. That day, the benchmark Hang Seng stock market index lost a stunning 1,211.47 points, at the time its largest one-day drop in history as speculators attacked both the currency and asset markets at the height of the first wave of the Asian crisis. As the Hong Kong dollar came under increasing attack, increasingly large amounts of Hong Kong dollars had to be withdrawn from the domestic money supply as required by the rules of the currency board. The Hong Kong Monetary Authority sat back and watched as the overnight borrowing rate skyrocketed to 3000o. The combination of soaring interest rates and heavy foreign exchange intervention caused USD-HKD to hit an intraday low of 7.4800, compared to usual trading levels at the time of around
7.7450, as the Hong Kong dollar screamed higher against the U.S. dollar in the wake of panicked speculators desperately trying to get out of their short Hong Kong dollar positions. October 23, 1997 was a day of high drama, a day when investors throughout the territory gazed up at public stock market screens in horror as the Hang Seng was smashed, a day when the speculators thought they were winning and ended up very badly burned as sky-high interest rates caused their funding costs to soar, a day the HKMA was tested and not found wanting. It was not to be the last time that the HKMA was tested however, far from it, though the bruising which the speculators took on that day caused many to take quite some time before they returned to have another go.
Basically, the options open to the Hong Kong authorities came down to two: hold the peg or let it go. The authorities chose to hold it at all costs, in the face of significant criticism from financial and economic commentators (mostly outside Hong Kong, and who were thus not exposed to the result of a de-peggingO and rightly so. As I argued at the time, a dc-pegging or an adjustment/devaluation of the Hong Kong dollar would have been catastrophic for Hong Kong. Many at the time said that Hong Kong needed to devalue in order for it to regain trade competitiveness lost to its major competitors in the wake of the ASEAN and North Asian currency devaluations during the Asian currency crisis. This logic is deeply flawed. Returning to the strict definition of the exchange rate regime in Hong Kong, the Hong Kong dollar is not pegged as several ASEAN currencies were pegged to the dollar at the time (only for those pegs to be blown apart), but is instead linked to the U.S. dollar via a currency board, whereby the HKMA, the monetary authority of Hong Kong in lieu of a standard central bank, guarantees to sell dollars at a rate of 7.80 Hong Kong dollars to the market, backing that guarantee with its own foreign exchange reserves from the Exchange Fund.
The currency board survived its test in October 1997, just as it had many before that (and subsequently), and by the end of the first quarter slightly more favourable liquidity conditions had allowed a relaxation in domestic Hong Kong interest rates, causing the spread between the 3-month HIBOR rate and the Fed funds’ target rate to finally dip back below pre-crisis levels. This was to be a temporary relief however for the Hong Kong markets and for the exchange rate system, which started to come under renewed attack in June and July of 1998. Local interest rates were forced sharply higher, while the stock market turned South, falling to a 1998 low of 6,544.79 from above 16,000 in 1997. At the time, speculators had discovered a way of “manipulating” the local markets as the HKMA would later charge, selling the Hang Seng futures, borrowing Hong Kong dollars and selling them short against the U.S. dollar, thus forcing interest rates higher. What they lost on their Hong Kong dollar borrowing, they more than made up for on their short Hang Seng futures’ and short Hong Kong dollar positions, seemingly free money. A large scale attack on the Hong Kong dollar and Hong Kong asset markets took place in early August of 1998. The Hong Kong authorities, not surprisingly took exception to this given that the economy remained mired in deep recession and higher interest rates would exacerbate that. Trading in Hang Seng stock index futures exploded in early August, with gross open interest in the front end contract rising to 92,000 contracts from 70,000 in June. Eventually, the Hong Kong authorities decided to do something about this, with the Financial Secretary and the HKMA Chief Executive Joseph Yam giving approval for the HKMA desk to intervene in the stock market with the specific aim of eliminating the speculative presence. From August 14-28, the HKMA bought cash stocks and Hang Seng futures, with a total worth of around HKD11O bin, causing the Hang Seng to rebound back above the 10,000 level. Incredibly, the HKMA had taken on the markets and won - again - but this did not come without a deluge of criticism, both from within Hong Kong this time and externally that the authorities, by intervening in the market had effectively abandoned their free- market principles.
The HKMA followed this up in September by introducing a number of measures to boost the overall market liquidity, when measured it caused the Hong Kong dollar to halve almost instantly, further burning the speculators. The package of measures contained two major provisions: a convertibility undertaking to demonstrate the authorities’ commitment to the currency board and a cushion of liquidity through a series of technical improvements to that currency board system. On the first, the HKMA provided a crystal clear undertaking to licensed banks to convert Hong Kong dollars in their clearing accounts into U.S. dollars at a fixed rate of HKD7.75 to the U.S. dollar. In addition, from April 1, 1999, that convertibility undertaking exchange rate of 7.7500 would change by 1 pip per
calendar day, taking 500 calendar days to complete the move to 7.80.
On the second provision, the HKMA made a commitment to increase
systemic liquidity reducing the ability of speculators to manipulate
the market, which was what the HKMA saw as levelling the playing
field. More specifically, the HKMA suggested 6 specific measures:
1. Removing the bid rate of the Liquidity Adjustment Facility (LAF)., thus
r keeping more interbank funds in the system.
2. Replacing the LAF with a discount window with the base rate of that
(formerly the LAF’s offer rate) to be determined occasionally by the
HKMA but in general by the market.
3. Removing the restriction on repeated borrowing of overnight Hong
Kong dollar liquidity through repo transactions using Exchange Fund
Bills and Notes.
4. New Exchange Fund paper to be issued only when there is an inflow of
funds, ensuring that all EF paper is fully backed by foreign exchange
reserves.
5. Introducing a schedule of discount rates applicable for different
percentage thresholds of holdings of Exchange Fund paper by the
licensed banks for the purpose of accessing the discount window.
6. Retaining the restriction on repeated borrowing in respect of repo
transactions involving debt securities other than Exchange Fund paper.
Joseph Yam, the HKMA Chief Executive, said: “These measures aim at strengthening Hong Kong’s currency board arrangements and achieving an even higher degree of transparency and disclosure. They will enhance the robustness of Hong Kong’s monetary arrangement, characterized by the linked exchange rate system. They should also help to reduce excessive volatility in interest rates.”4
The measures were aimed at significantly boosting systemic liquidity and at the same time increasing transparency of the currency board system, thus allowing the potential for the market itself to offset speculative interest. Despite further criticism of these measures and ongoing criticism of the stock market intervention, it is no exaggeration to say that this package of measures was brilliant. In addition to those stated aims, they eliminated much of the market concern regarding the HKMA’s previous apparent policy of stating a convertibility rate of 7.80 to the dollar while actively intervening in the foreign exchange market at 7.7500, thus allowing the potential for arbitrage and putting into question its commitment to the currency board - if the HKMA believed in the strength and efficacy of the currency board system, why did it need to intervene at all instead of letting the mechanism work.
The HKMA’s response to repeated attacks against the currency board system attracted praise from none other than the New York Fed President William McDonough for its steadfastness and resiliency in the face of the most trying of financial market conditions. Yet, while it seemed to have won a series of battles, the fundamental economic situation remained dire. After seeing its economy expand by an impressive 5.3 in 1997 - the height of the boom in local asset markets, in the run up to the Handover on July 1, 1997 - Hong Kong’s conomy contracted by 5.1 in 1998, a stunning reversal of lO.4 points. Unlike other Asian countries which saw their currency depreciate, deliberately or inadvertently as a result of the crisis, Hong Kong did not have that luxury given the currency board peg requirement. Equally, on the fiscal side, the HKSAR - Hong Kong Special Administrative Region of China - was restrained by the Basic Law from having significant fiscal deficits which would be deemed fundamentally imprudent. Hong Kong ran a budget deficit of -2.5 of the GDP in 1998 on the basis that this was an emergency situation, which is likely to have been followed by a deficit of -2.9 in 1999. Despite some degree of deficit spending and a cut in the national income tax, the main brunt of the adjustment fell on the three main pillars of the Hong Kong economy: property, financial services and tourism/retail trade. On the first issue, the government, which remains the sole owner of remaining plots of land due to the Colonial heritage of the place, ceased having new auctions to try and rebalance the supply/demand equation. The second issue, resulted in mass layoffs of bank staff as financial institutions sought to downsize to reflect greatly reduced demand for financial product, of whatever sort. On the third, tourism collapsed.
Fundamentally, this adjustment in the form of asset prices and demand was actually no bad thing, for Hong Kong by 1997 was an extremely expensive, un-competitive place, as reflected most clearly by house prices (which doubled from January-June 1997 alone). Hong Kong did not have the problems that Thailand, Indonesia and Korea had, namely of excessive short-term foreign currency debt and a shaky banking system. On the contrary, the HKMA was a very prudent and sound regulator of the banking system, ensuring the maintenance of bank capital adequacy ratios substantially in excess of the Bank of International Settlements (BIS) requirements. No, Hong Kong’s problem was one simply of loss of price competitiveness, a loss which was shown up and greatly exacerbated by the Asian currency devaluations against the Hong Kong dollar as well as the U.S. dollar in the wake of the crisis given Hong Kong’s need to maintain a fixed exchange rate commitment. The HKMA was right to maintain that commitment to the currency board system at the time, during the crisis given that the alternative would have courted a financial disaster potentially worse than Thailand given the proportion of the U.S. dollar and Hong Kong dollar assets in the system as a result of the currency board, and more specifically the fact that the domestic banking system’s capital base was in Hong Kong dollars. If the peg had been let go at any time during the crisis, the resulting devaluation of the Hong Kong dollar could not have been limited and would have caused a proportional devaluation of the banking system’s capital base. It would have caused the one thing it had not done to any degree up until that point, a loss of confidence in the domestic supervisory institutions and in the domestic banking system. There would have been mass panic, runs on banks. The banking system would have imploded, domestic interest rates would have skyrocketed rather than fallen as demand for Hong Kong dollars collapsed and the stock market and the economy would have gone into meltdown. It would have been the type and degree of financial catastrophe from which it would have taken Hong Kong decades to recover. During the crisis, there was absolutely no benefit to the HKMA in letting the peg go, and every reason to maintain it. Those who called for its abandonment were talking utter nonsense. This does not mean to say that a currency board cannot be eventually replaced by another form of exchange rate regime. It is to say that if the currency board system had been seen to be defeated, it would have caused disaster, and not just for Hong Kong. All other currency boards in the world would have been instantly targeted. Argentina has much to thank Hong Kong for, and vice versa.
Going forward, Hong Kong may decide that a policy change is necessary given more suitable conditions and fundamentals, however what it did in 199 7-98, maintaining the peg at all cost was exactly the right thing to do. Anything else would have been disgracefully irresponsible. The Hong Kong authorities also, justifiably, deserve much praise. What one can say however is that their policy response was not asymmetric. They intervened against what they saw as excessive and manipulative selling pressure against the Hong Kong dollar and its asset markets, but they were not so similarly zealous when those same asset markets were rallying excessively in 1996-97. Was this not also speculation? It is not a sufficient answer for the HKMA to say that they do not intervene in financial markets, since they plainly did do exactly that in August 1998. It would not have been beyond the remit of the monetary authority at the time to warn against the potential dangers of speculative gains, indeed it should have done so, though political factors ahead of the Handover might have made that somewhat difficult and a sensitive issue in practice.
7.80 Hong Kong dollars to the U.S. dollar. What the Hong Kong authorities themselves call a linked exchange rate regime (i.e, a currency board) is designed to allow Hong Kong interest rates to adjust automatically to currency pressures via changes in domestic money supply, whereby the selling of Hong Kong dollars results in an equal reduction in the Hong Kong dollar money supply, thus causing interest rates to rise. Eventually, as the logic of the currency board system goes, domestic Hong Kong interest rates reach a level which attracts renewed investor interest in the Hong Kong dollar, causing purchases of that currency and subsequently an equal and opposite increase in the supply of Hong Kong dollars to the system, thus causing interest rates to fall back once more. In theory, the system is beautifully and elegantly simple. However, the practice of financial markets can be somewhat more violent. The date of October 23, 1997 was the first of several to be etched in the minds of those who watched the Hong Kong markets during the crisis. That day, the benchmark Hang Seng stock market index lost a stunning 1,211.47 points, at the time its largest one-day drop in history as speculators attacked both the currency and asset markets at the height of the first wave of the Asian crisis. As the Hong Kong dollar came under increasing attack, increasingly large amounts of Hong Kong dollars had to be withdrawn from the domestic money supply as required by the rules of the currency board. The Hong Kong Monetary Authority sat back and watched as the overnight borrowing rate skyrocketed to 3000o. The combination of soaring interest rates and heavy foreign exchange intervention caused USD-HKD to hit an intraday low of 7.4800, compared to usual trading levels at the time of around
7.7450, as the Hong Kong dollar screamed higher against the U.S. dollar in the wake of panicked speculators desperately trying to get out of their short Hong Kong dollar positions. October 23, 1997 was a day of high drama, a day when investors throughout the territory gazed up at public stock market screens in horror as the Hang Seng was smashed, a day when the speculators thought they were winning and ended up very badly burned as sky-high interest rates caused their funding costs to soar, a day the HKMA was tested and not found wanting. It was not to be the last time that the HKMA was tested however, far from it, though the bruising which the speculators took on that day caused many to take quite some time before they returned to have another go.
Basically, the options open to the Hong Kong authorities came down to two: hold the peg or let it go. The authorities chose to hold it at all costs, in the face of significant criticism from financial and economic commentators (mostly outside Hong Kong, and who were thus not exposed to the result of a de-peggingO and rightly so. As I argued at the time, a dc-pegging or an adjustment/devaluation of the Hong Kong dollar would have been catastrophic for Hong Kong. Many at the time said that Hong Kong needed to devalue in order for it to regain trade competitiveness lost to its major competitors in the wake of the ASEAN and North Asian currency devaluations during the Asian currency crisis. This logic is deeply flawed. Returning to the strict definition of the exchange rate regime in Hong Kong, the Hong Kong dollar is not pegged as several ASEAN currencies were pegged to the dollar at the time (only for those pegs to be blown apart), but is instead linked to the U.S. dollar via a currency board, whereby the HKMA, the monetary authority of Hong Kong in lieu of a standard central bank, guarantees to sell dollars at a rate of 7.80 Hong Kong dollars to the market, backing that guarantee with its own foreign exchange reserves from the Exchange Fund.
The currency board survived its test in October 1997, just as it had many before that (and subsequently), and by the end of the first quarter slightly more favourable liquidity conditions had allowed a relaxation in domestic Hong Kong interest rates, causing the spread between the 3-month HIBOR rate and the Fed funds’ target rate to finally dip back below pre-crisis levels. This was to be a temporary relief however for the Hong Kong markets and for the exchange rate system, which started to come under renewed attack in June and July of 1998. Local interest rates were forced sharply higher, while the stock market turned South, falling to a 1998 low of 6,544.79 from above 16,000 in 1997. At the time, speculators had discovered a way of “manipulating” the local markets as the HKMA would later charge, selling the Hang Seng futures, borrowing Hong Kong dollars and selling them short against the U.S. dollar, thus forcing interest rates higher. What they lost on their Hong Kong dollar borrowing, they more than made up for on their short Hang Seng futures’ and short Hong Kong dollar positions, seemingly free money. A large scale attack on the Hong Kong dollar and Hong Kong asset markets took place in early August of 1998. The Hong Kong authorities, not surprisingly took exception to this given that the economy remained mired in deep recession and higher interest rates would exacerbate that. Trading in Hang Seng stock index futures exploded in early August, with gross open interest in the front end contract rising to 92,000 contracts from 70,000 in June. Eventually, the Hong Kong authorities decided to do something about this, with the Financial Secretary and the HKMA Chief Executive Joseph Yam giving approval for the HKMA desk to intervene in the stock market with the specific aim of eliminating the speculative presence. From August 14-28, the HKMA bought cash stocks and Hang Seng futures, with a total worth of around HKD11O bin, causing the Hang Seng to rebound back above the 10,000 level. Incredibly, the HKMA had taken on the markets and won - again - but this did not come without a deluge of criticism, both from within Hong Kong this time and externally that the authorities, by intervening in the market had effectively abandoned their free- market principles.
The HKMA followed this up in September by introducing a number of measures to boost the overall market liquidity, when measured it caused the Hong Kong dollar to halve almost instantly, further burning the speculators. The package of measures contained two major provisions: a convertibility undertaking to demonstrate the authorities’ commitment to the currency board and a cushion of liquidity through a series of technical improvements to that currency board system. On the first, the HKMA provided a crystal clear undertaking to licensed banks to convert Hong Kong dollars in their clearing accounts into U.S. dollars at a fixed rate of HKD7.75 to the U.S. dollar. In addition, from April 1, 1999, that convertibility undertaking exchange rate of 7.7500 would change by 1 pip per
calendar day, taking 500 calendar days to complete the move to 7.80.
On the second provision, the HKMA made a commitment to increase
systemic liquidity reducing the ability of speculators to manipulate
the market, which was what the HKMA saw as levelling the playing
field. More specifically, the HKMA suggested 6 specific measures:
1. Removing the bid rate of the Liquidity Adjustment Facility (LAF)., thus
r keeping more interbank funds in the system.
2. Replacing the LAF with a discount window with the base rate of that
(formerly the LAF’s offer rate) to be determined occasionally by the
HKMA but in general by the market.
3. Removing the restriction on repeated borrowing of overnight Hong
Kong dollar liquidity through repo transactions using Exchange Fund
Bills and Notes.
4. New Exchange Fund paper to be issued only when there is an inflow of
funds, ensuring that all EF paper is fully backed by foreign exchange
reserves.
5. Introducing a schedule of discount rates applicable for different
percentage thresholds of holdings of Exchange Fund paper by the
licensed banks for the purpose of accessing the discount window.
6. Retaining the restriction on repeated borrowing in respect of repo
transactions involving debt securities other than Exchange Fund paper.
Joseph Yam, the HKMA Chief Executive, said: “These measures aim at strengthening Hong Kong’s currency board arrangements and achieving an even higher degree of transparency and disclosure. They will enhance the robustness of Hong Kong’s monetary arrangement, characterized by the linked exchange rate system. They should also help to reduce excessive volatility in interest rates.”4
The measures were aimed at significantly boosting systemic liquidity and at the same time increasing transparency of the currency board system, thus allowing the potential for the market itself to offset speculative interest. Despite further criticism of these measures and ongoing criticism of the stock market intervention, it is no exaggeration to say that this package of measures was brilliant. In addition to those stated aims, they eliminated much of the market concern regarding the HKMA’s previous apparent policy of stating a convertibility rate of 7.80 to the dollar while actively intervening in the foreign exchange market at 7.7500, thus allowing the potential for arbitrage and putting into question its commitment to the currency board - if the HKMA believed in the strength and efficacy of the currency board system, why did it need to intervene at all instead of letting the mechanism work.
The HKMA’s response to repeated attacks against the currency board system attracted praise from none other than the New York Fed President William McDonough for its steadfastness and resiliency in the face of the most trying of financial market conditions. Yet, while it seemed to have won a series of battles, the fundamental economic situation remained dire. After seeing its economy expand by an impressive 5.3 in 1997 - the height of the boom in local asset markets, in the run up to the Handover on July 1, 1997 - Hong Kong’s conomy contracted by 5.1 in 1998, a stunning reversal of lO.4 points. Unlike other Asian countries which saw their currency depreciate, deliberately or inadvertently as a result of the crisis, Hong Kong did not have that luxury given the currency board peg requirement. Equally, on the fiscal side, the HKSAR - Hong Kong Special Administrative Region of China - was restrained by the Basic Law from having significant fiscal deficits which would be deemed fundamentally imprudent. Hong Kong ran a budget deficit of -2.5 of the GDP in 1998 on the basis that this was an emergency situation, which is likely to have been followed by a deficit of -2.9 in 1999. Despite some degree of deficit spending and a cut in the national income tax, the main brunt of the adjustment fell on the three main pillars of the Hong Kong economy: property, financial services and tourism/retail trade. On the first issue, the government, which remains the sole owner of remaining plots of land due to the Colonial heritage of the place, ceased having new auctions to try and rebalance the supply/demand equation. The second issue, resulted in mass layoffs of bank staff as financial institutions sought to downsize to reflect greatly reduced demand for financial product, of whatever sort. On the third, tourism collapsed.
Fundamentally, this adjustment in the form of asset prices and demand was actually no bad thing, for Hong Kong by 1997 was an extremely expensive, un-competitive place, as reflected most clearly by house prices (which doubled from January-June 1997 alone). Hong Kong did not have the problems that Thailand, Indonesia and Korea had, namely of excessive short-term foreign currency debt and a shaky banking system. On the contrary, the HKMA was a very prudent and sound regulator of the banking system, ensuring the maintenance of bank capital adequacy ratios substantially in excess of the Bank of International Settlements (BIS) requirements. No, Hong Kong’s problem was one simply of loss of price competitiveness, a loss which was shown up and greatly exacerbated by the Asian currency devaluations against the Hong Kong dollar as well as the U.S. dollar in the wake of the crisis given Hong Kong’s need to maintain a fixed exchange rate commitment. The HKMA was right to maintain that commitment to the currency board system at the time, during the crisis given that the alternative would have courted a financial disaster potentially worse than Thailand given the proportion of the U.S. dollar and Hong Kong dollar assets in the system as a result of the currency board, and more specifically the fact that the domestic banking system’s capital base was in Hong Kong dollars. If the peg had been let go at any time during the crisis, the resulting devaluation of the Hong Kong dollar could not have been limited and would have caused a proportional devaluation of the banking system’s capital base. It would have caused the one thing it had not done to any degree up until that point, a loss of confidence in the domestic supervisory institutions and in the domestic banking system. There would have been mass panic, runs on banks. The banking system would have imploded, domestic interest rates would have skyrocketed rather than fallen as demand for Hong Kong dollars collapsed and the stock market and the economy would have gone into meltdown. It would have been the type and degree of financial catastrophe from which it would have taken Hong Kong decades to recover. During the crisis, there was absolutely no benefit to the HKMA in letting the peg go, and every reason to maintain it. Those who called for its abandonment were talking utter nonsense. This does not mean to say that a currency board cannot be eventually replaced by another form of exchange rate regime. It is to say that if the currency board system had been seen to be defeated, it would have caused disaster, and not just for Hong Kong. All other currency boards in the world would have been instantly targeted. Argentina has much to thank Hong Kong for, and vice versa.
Going forward, Hong Kong may decide that a policy change is necessary given more suitable conditions and fundamentals, however what it did in 199 7-98, maintaining the peg at all cost was exactly the right thing to do. Anything else would have been disgracefully irresponsible. The Hong Kong authorities also, justifiably, deserve much praise. What one can say however is that their policy response was not asymmetric. They intervened against what they saw as excessive and manipulative selling pressure against the Hong Kong dollar and its asset markets, but they were not so similarly zealous when those same asset markets were rallying excessively in 1996-97. Was this not also speculation? It is not a sufficient answer for the HKMA to say that they do not intervene in financial markets, since they plainly did do exactly that in August 1998. It would not have been beyond the remit of the monetary authority at the time to warn against the potential dangers of speculative gains, indeed it should have done so, though political factors ahead of the Handover might have made that somewhat difficult and a sensitive issue in practice.
SINGAPORE
The case of Singapore concerns one of fundamentally superior economic managsment. One of the most open trading nations in Asia, it was especially vulnerable to the collapse in inter-Asian regional trade which resulted from the Asian regional crisis. Well aware that competitive devaluations by its trading partners could result in a loss of competitiveness, the Singaporean authorities set about restoring that competitiveness through a series of microeconomic and budgetary measures, most notably including a 15 point cut in the employer contribution to the CPF, the national provident (pension) fund compulsory for domestic workers. Prior to the crisis, Singapore was already running a current account surplus of over 1 5 of the GDP so it had a substantial cushion to limit the damage to its currency. As a result of the downturn in domestic demand, that current account surplus almost reached 21 in 1998 and is expected it to be just over 17 in 1999. Outside of China, Singapore and Taiwan were the only countries which did not see their economies contract in 1998 in the emerging Asian region which we follow. Singapore saw growth of +0.3 and on current form this is likely to be followed by a growth of
6.0 in 1999 and 8.0 in 2000. How did this happen? The Singaporean authorities allowed greater flexibility in tracking the Singapore dollar against its basket of trading currencies, thereby implying a modest depreciation, but they explicitly did not allow a devaluation of the currency for the purpose of maintaining or expanding trade competitiveness. Thus, while the Singapore dollar was allowed to weaken slightly at the height of the crisis, from a high against the dollar in May 1995 of 1.3830 to a crisis low of 1.8 160, the crisis-related depreciation of the Singapore dollar from 1997 through the end of 1998 was around 25%, comparing favourably with devaluations of 40-50 for the Thai baht and the Philippine peso, with the Indonesian rupiah losing an astounding 80% of its value at one point. The Singapore dollar could not but be swept along to an extent by the crisis, but the important point was that investor confidence in the handling of the economic and financial fundamentals of the country remained assured. While Singapore did not take the road of devaluation, it also avoided the policy U-turn by IMP programme countries which are now looking at budget deficits of around 6 of GDP for 1999. The Singaporean authorities allowed a budget deficit of just -0.3 of the GDP in 1998, followed by an estimated -1.5% in 1999 which is likely to be flat in the year 2000. Strong long-term fundamentals, a prudent policy mix and a clear focus on maintaining the overall cost competitiveness of the economy, through allowing the market mechanism for re-pricing the domestic property market and through cutting the employer cost base through the CPF contribution reduction, were the foundations for the city state’s rock solid economic performance. Without any sense of false flattery whatsoever, the Singaporean economic and financial authorities are among the most impressive anywhere in terms of their skill in running the economy.
6.0 in 1999 and 8.0 in 2000. How did this happen? The Singaporean authorities allowed greater flexibility in tracking the Singapore dollar against its basket of trading currencies, thereby implying a modest depreciation, but they explicitly did not allow a devaluation of the currency for the purpose of maintaining or expanding trade competitiveness. Thus, while the Singapore dollar was allowed to weaken slightly at the height of the crisis, from a high against the dollar in May 1995 of 1.3830 to a crisis low of 1.8 160, the crisis-related depreciation of the Singapore dollar from 1997 through the end of 1998 was around 25%, comparing favourably with devaluations of 40-50 for the Thai baht and the Philippine peso, with the Indonesian rupiah losing an astounding 80% of its value at one point. The Singapore dollar could not but be swept along to an extent by the crisis, but the important point was that investor confidence in the handling of the economic and financial fundamentals of the country remained assured. While Singapore did not take the road of devaluation, it also avoided the policy U-turn by IMP programme countries which are now looking at budget deficits of around 6 of GDP for 1999. The Singaporean authorities allowed a budget deficit of just -0.3 of the GDP in 1998, followed by an estimated -1.5% in 1999 which is likely to be flat in the year 2000. Strong long-term fundamentals, a prudent policy mix and a clear focus on maintaining the overall cost competitiveness of the economy, through allowing the market mechanism for re-pricing the domestic property market and through cutting the employer cost base through the CPF contribution reduction, were the foundations for the city state’s rock solid economic performance. Without any sense of false flattery whatsoever, the Singaporean economic and financial authorities are among the most impressive anywhere in terms of their skill in running the economy.
MALAYSIA
In the case of Malaysia, the government not only had to combat the full force of the crisis, it also had to deal with a growing policy quarrel between Prime Minister Dr. Mahathir Mohamed and Deputy Prime Minister Anwar Ibrahim, the former railing against the market, blaming Western currency speculators for impoverishing his country and the region as a whole and saying that currency trading should be banned, the latter championing the free market and supporting the IMF’s case of fiscal and monetary tightening. Mahathir fired his Deputy Anwar, who was subsequently arrested and convicted on several charges. The Governor and Deputy Governor of the central bank, Bank Negara Malaysia, resigned and the following week, on September 1998, Malaysia imposed capital and exchange controls, fixing the ringgit at 3.80 to the dollar and banning the offshore spot and forward ringgit markets. As a result of this, domestic liquidity increased, allowing interest rates to be lowered, thus reducing the debt service burden on the domestic corporate base and banking system, an important consideration given that Malaysia’s total debt to GDP at the time was around l6O Malaysia is currently undergoing a strong growth recovery and GDP growth is anticipated at 4.8 in 1999 and 5.0 in 2000 after a 7.5 contraction in 1998.
THE IMF’s U-TURN
Somewhere along the way, the IMF had a change of heart. Though the ideological spat with the World Bank’s Joseph Stiglitz is unlikely to have caused it directly, that did serve to cause the IMF to defend publicly their programme’s principal condition of fiscal austerity. In addition, the near collapse of Korea, a country which had only recently been elevated to the OECD - and thus presumably getting as close to an emerged status as a country can be while remaining emerging” - caused a realisation that the problems of first Thailand, then Indonesia and finally Korea were not isolated incidents, but part of a regional, if not a global crisis and that the private sector had to be more involved in the resolution of the debt crisis. In addition, there was the realisation, however belated, of the sheer catastrophic degree of damage done to the Asian economies as a result of the currency devaluations and consequent debt re-valuations, economic damage which had actually been exacerbated by the IMF’s own demands for fiscal austerity. Certainly, there was the realisation within the IMF that more effective procedures had to be created to involve the private sector in emerging market currency and debt crises. In addition, there was the belated recognition of the specific nature of private rather than public debt crises. Two IMF internal reports appeared to call into question the randomness of bank closures and the appropriateness of fiscal austerity.
Once Asian external gaps had been closed by the end of the first quarter of 1998 and currencies had been stabilised, the IMF finally started to listen to Asian government requests for flexibility in terms of the fiscal account given the extent of the pain being felt by their economies and populations. Indeed, the JMF went so far as to allow Thailand, Indonesia and Korea to run significant budget deficits for both 1998 and 1999 in return for further moves to open up their markets, reduce and restructure corporate debt and strengthen institutional infrastructure. From a budget surplus of +2.2 of GDP in 1996, Thailand ran a budget deficit of i.0 in 1997 (initially targeted at a surplus of + 1.000 by the IMF) followed by -2.3 in 1998 and -6.0 estimated in 1999. Korea is also expected to have recorded a budget deficit of -6.0 in 1999, after -2.9 in 1998, such was the extent of the IMF U-turn on fiscal policy. Credit where credit is due: this reflected the realisation that financial conditions had been stabilised and the priority going forward was to stabilise the economic situation and alleviate the suffering of domestic populations. The fact that the programme countries were now running trade and current account surpluses (because their economies had collapsed and thus imports had collapsed) provided a much needed funding cushion and in addition acted as a stabilising factor for Asian currencies, allowing them greater flexibility in this regard.
In particular, the IMF allowed for programme-member Asian countries to expand social spending to mitigate against the worst demand factors resulting from the effects of the crisis and the initial fiscal and monetary austerity which had been necessary in order to close external gaps and to stabilise currencies. In the case of Indonesia, the overall budget cost of social safety net programmes was initially put at 8 of the GDP per annum, a financial hole which the IMF helped plug. Up until the first quarter of 1998, the programme member fiscal targets remained contractionary, but after that they became expansionary as the IMF allowed the three programme members to increase social spending, seeking to reduce the worst of the burden on the poor. There was a condition however and that was that deficit spending had to be financed through viable borrowing rather than monetary creation in order to avoid the potential threat of further inflationary impulses. In addition, there was the deliberate attempt to avoid increased fiscal deficits resulting in higher domestic interest rates. Through the joint efforts of the World Bank, deficit spending was aimed to help the poor, and to provide the necessary funding for the cash-strapped corporate sector. Monetary policy was similarly allowed to be expansionary, in line with easier fiscal policy after currencies were stabilised.
This belated flexibility on the part of the IMF was welcome. There were however Asian countries which suffered similarly or even equally amidst the hurricane of the Asian crisis which did not go the way of the IMF. These were divided into two types: those who sought to go their own way, rejecting both the idea of IMF help and ultimately of exchange rate flexibility (Malaysia), and secondly those who did not seek IMF aid but used policies similar to those promoted by the IMF in seeking to deal with the crisis, through their own best efforts and superior economic management (Hong Kong and Singapore).
Once Asian external gaps had been closed by the end of the first quarter of 1998 and currencies had been stabilised, the IMF finally started to listen to Asian government requests for flexibility in terms of the fiscal account given the extent of the pain being felt by their economies and populations. Indeed, the JMF went so far as to allow Thailand, Indonesia and Korea to run significant budget deficits for both 1998 and 1999 in return for further moves to open up their markets, reduce and restructure corporate debt and strengthen institutional infrastructure. From a budget surplus of +2.2 of GDP in 1996, Thailand ran a budget deficit of i.0 in 1997 (initially targeted at a surplus of + 1.000 by the IMF) followed by -2.3 in 1998 and -6.0 estimated in 1999. Korea is also expected to have recorded a budget deficit of -6.0 in 1999, after -2.9 in 1998, such was the extent of the IMF U-turn on fiscal policy. Credit where credit is due: this reflected the realisation that financial conditions had been stabilised and the priority going forward was to stabilise the economic situation and alleviate the suffering of domestic populations. The fact that the programme countries were now running trade and current account surpluses (because their economies had collapsed and thus imports had collapsed) provided a much needed funding cushion and in addition acted as a stabilising factor for Asian currencies, allowing them greater flexibility in this regard.
In particular, the IMF allowed for programme-member Asian countries to expand social spending to mitigate against the worst demand factors resulting from the effects of the crisis and the initial fiscal and monetary austerity which had been necessary in order to close external gaps and to stabilise currencies. In the case of Indonesia, the overall budget cost of social safety net programmes was initially put at 8 of the GDP per annum, a financial hole which the IMF helped plug. Up until the first quarter of 1998, the programme member fiscal targets remained contractionary, but after that they became expansionary as the IMF allowed the three programme members to increase social spending, seeking to reduce the worst of the burden on the poor. There was a condition however and that was that deficit spending had to be financed through viable borrowing rather than monetary creation in order to avoid the potential threat of further inflationary impulses. In addition, there was the deliberate attempt to avoid increased fiscal deficits resulting in higher domestic interest rates. Through the joint efforts of the World Bank, deficit spending was aimed to help the poor, and to provide the necessary funding for the cash-strapped corporate sector. Monetary policy was similarly allowed to be expansionary, in line with easier fiscal policy after currencies were stabilised.
This belated flexibility on the part of the IMF was welcome. There were however Asian countries which suffered similarly or even equally amidst the hurricane of the Asian crisis which did not go the way of the IMF. These were divided into two types: those who sought to go their own way, rejecting both the idea of IMF help and ultimately of exchange rate flexibility (Malaysia), and secondly those who did not seek IMF aid but used policies similar to those promoted by the IMF in seeking to deal with the crisis, through their own best efforts and superior economic management (Hong Kong and Singapore).
KOREA
Even more melodramatic and colourful events had been taking place some way North of Indonesia, in Seoul, Korea. At the end of Noverriber 1997, Korea, the 1 1’ largest economy in the world and recently promoted to the OECD, had come within a whisker of defaulting, saved at the 1 1t and three quarterth hour by a combination of the U.S. administration and the IMF. The first days as U.S. Treasury Secretary in December 1994 and January 1995 of Robert Rubin had been a baptism of fire in having to deal with the Mexican currency crisis and its international market ramifications. His already extensive market experience notwithstanding, this period an ideal training ground for the task of leading the decidedly more complex international effort to speed up the loan packages, particularly to Korea and to persuade commercial and investment banks to roll over debt obligations owed to them. On December 24, subsequent to the announcement by the Korean government of a package of reforms designed to restructure the financial system, accelerate and deepen capital account liberalisation, introduce market-based measures to stem the outflow of short-term capital and speed up measures to open the real economy to foreign trade and investment, Rubin made the following statement:
‘We have supported a broad international effort to restore stability in Asia. This effort is critically important to U.S. economic and national security interests. We welcome the steps announced today to the Korean government to strengthen and accelerate its reform programme. These important steps demonstrate the commitment to sustained reform that is essential to a successful programme to restore confidence and return Korea to a path of growth and stability.. The G7 and other nations have announced today their support of action to advance by early January existing commitments of official finance, in the context of a sustained commitment by the Korean authorities to implement an intensified programme and in the context of a significant voluntary extension of the maturities of the existing claims by international bank creditors on Korean financial institutions and adequate progress by Korea towards accessing new sources of private international finance. The United States is prepared to join with the G-7 and other countries in this effort”2
The efforts by the U.S. financial authorities, in the form of the Treasury and the Federal Reserve, along with other Western nations has been crucial in seeking to avoid mass Asian corporate and banking defaults - and, for that matter, a consequent spike in Western bank loan write-offs. Indeed, without these efforts, the IMF loan packages would not have been enough.
rhe model adopted by the IMF for the bailout package of Korea did not quite reflect the subsequent U-turn in its fundamental macroeconomic thinking which was to come, but it did represent an important change, perhaps, in that direction. For the international (i.e. Western) community, it also represented an important change. Up until then, the response from the U.S. and Europe had been sympathetic, but far from unequivocal in terms of concrete support. The U.S. sought to ensure strict terms and conditions for the IMF packages, as fundamental analysis might indeed justify however this was also in full knowledge that U.S. banks had only moderate loan exposure to Asian debtors - the lessons of Mexico 1982 and Mexico 1995 having been well, if painfully learned. The EU, meanwhile, had far greater loan exposure to Asia, European banks having greedily sought to fill the gap left by Japanese banks who quietly started to depart the scene or at least to reduce their exposure in 1996. The option of demanding tough terms was thereby not open to EU officials, not in any case given to demonstrations of resolve against any but the weakest of emerging market countries. On the contrary, they pleaded for softer terms than their U.S. counterparts, fearful that Asian debtors might default, while paying the greater share of IMF contributions, the purpose of which was of course to ensure that default did not occur.
Korea was different in many respects to Thailand and Indonesia, most notably because it had vital geopolitical and strategic interest to the U.S., in addition to its new-found economic status. Put simply, Korea was vital to U.S. national security interests - seen most visibly by the U.S. military presence on the DMZ - and Thailand and Indonesia were not, or not so much. Korea could not be allowed to fail. The bailout was arranged along two lines, the first concerning the IMF negotiations with the Korean government, the second regarding pressure from the Federal Reserve, Bank of England, Bundesbank and others to persuade the international banking community to roll over short-term foreign currency debts, allowing the Korean government the time theoretically to fill the gap through new debt issues.
For Korea, the avoidance of default in December 1997 had been a very close run thing indeed. The New York Fed has summoned senior officials of the 6 largest banks to its Liberty Street headquarters for a meeting on the Korean situation. Korea was experiencing net outflows of over USD1 billion a day and its usual foreign exchange reserves were not much more than USD5 billion. The banks were encouraged to maintain credit lines to Korea on the view that it was in their own interest given that a Korean default would pose systemic risk to the global financial system. The banks’ agreement on this and subsequent agreement by UK and Europe provided Korea with the necessary, though brief breathing space in which to seek options for funding itself, stopping the outflows and boosting reserves.
The devaluation of the Korean won from around 800 to the dollar to a record low of 1985 had meant the amount of won needed to repay dollar debt had more than doubled and given that just under USD30 billion in short-term debt was due by the end of March 1998, this meant potential bankruptcy without outside aid. Korean corporate foreign currency debt from the top 30 chaebol and their numerous affiliates amounted to around USD60 billion. Following the foreign banks’ agreement to maintain credit lines, the Korean parliament in the first week of January passed the government’s proposal to extend some USD20 billion in government guarantees and to issue a total of USD10 billion in new debt. In late January it was announced that the Korean banks and a group of 13 leading international banks had agreed to extend the maturities of almost USD25 billion in short-term debts to the Korean banks, a further major step in the stabilisation of Korea.
On the Korean side, at one and the same time, the Koreans treated the crisis much like any other crisis of their history, as a national struggle for survival, and simultaneously as an opportunity for more hard-bargaining. On the edge of a financial precipice Korea might be, but its new government under President Kim Dae-jung was not without skill or guile in seeking to obtain more favourable terms. Kim was particularly well aware of the country’s need for new international private finance. One of his first acts as President was to invite George Soros, founder and head of the Soros Fund management, for a private meeting. In a press briefing afterwards, Soros reportedly said that he was seeking to increase significantly” the investment of his lead fund, the Quantum Fund, in Korean asset markets, though he first wanted to see significant corporate restructuring - which would inevitably result in painful but necessary heavy layoffs - greater corporate balance sheet transparency through the consolidation of accounts and labour market flexibility.3 ‘Ihat statement worked wonders for improving Kim Dae-jung’s reputation as a free-market reformer, and at the same time potentially attracting the interest of other Western institutional investors to the country. It was a masterstroke. Kim went further, reintroducing the concept of anonymous bank accounts which his predecessor had banned. The initial ban had caused discreet and black money to flee the country, putting pressure on the currency and interest rate markets. In opening up the economy to foreign ownership, while simultaneously promoting Korean national interests, Kim had to walk a tightrope. It was a high-wire act done with consummate skill, but not without compromise. A reformer he was - and is - but he was not about to tear down the structure, the very fabric of Korean corporate or political society. Kim’s other major success was in getting the unions, militant and moderate alike to agree to mass layoffs in return for unemployment pay, a concept inconceivable under previous Korean administrations.
Yet, while he led the reform element in the hope of attracting the necessary foreign capital to keep the economy and the financial system afloat, not all elements within Korea supported his efforts. The ruling party prior to Kim, which now formed a majority in the national Assembly did not appreciate seeing its corporate allies of long year forcibly restructured or rendered bankrupt and sought to frustrate the restucturing process through stalling bills in the parliament. Equally, the chaebol themselves, having gorged for years on cheap credit were hardly keen to go on a forced diet which in many cases involved the forced sale or liquidation of many of their own affiliates and subsidiaries. Many did not fulfil their part of Kim’s compact with the unions by paying unemployment pay, either because they wouldn’t or because they couldn’t meet such obligations. Meanwhile, the economic cost of the fiscal belt tightening which the IME demanded continued to bite into the soft flesh of the aconomy, hurting healthy and insolvent companies alike.
‘We have supported a broad international effort to restore stability in Asia. This effort is critically important to U.S. economic and national security interests. We welcome the steps announced today to the Korean government to strengthen and accelerate its reform programme. These important steps demonstrate the commitment to sustained reform that is essential to a successful programme to restore confidence and return Korea to a path of growth and stability.. The G7 and other nations have announced today their support of action to advance by early January existing commitments of official finance, in the context of a sustained commitment by the Korean authorities to implement an intensified programme and in the context of a significant voluntary extension of the maturities of the existing claims by international bank creditors on Korean financial institutions and adequate progress by Korea towards accessing new sources of private international finance. The United States is prepared to join with the G-7 and other countries in this effort”2
The efforts by the U.S. financial authorities, in the form of the Treasury and the Federal Reserve, along with other Western nations has been crucial in seeking to avoid mass Asian corporate and banking defaults - and, for that matter, a consequent spike in Western bank loan write-offs. Indeed, without these efforts, the IMF loan packages would not have been enough.
rhe model adopted by the IMF for the bailout package of Korea did not quite reflect the subsequent U-turn in its fundamental macroeconomic thinking which was to come, but it did represent an important change, perhaps, in that direction. For the international (i.e. Western) community, it also represented an important change. Up until then, the response from the U.S. and Europe had been sympathetic, but far from unequivocal in terms of concrete support. The U.S. sought to ensure strict terms and conditions for the IMF packages, as fundamental analysis might indeed justify however this was also in full knowledge that U.S. banks had only moderate loan exposure to Asian debtors - the lessons of Mexico 1982 and Mexico 1995 having been well, if painfully learned. The EU, meanwhile, had far greater loan exposure to Asia, European banks having greedily sought to fill the gap left by Japanese banks who quietly started to depart the scene or at least to reduce their exposure in 1996. The option of demanding tough terms was thereby not open to EU officials, not in any case given to demonstrations of resolve against any but the weakest of emerging market countries. On the contrary, they pleaded for softer terms than their U.S. counterparts, fearful that Asian debtors might default, while paying the greater share of IMF contributions, the purpose of which was of course to ensure that default did not occur.
Korea was different in many respects to Thailand and Indonesia, most notably because it had vital geopolitical and strategic interest to the U.S., in addition to its new-found economic status. Put simply, Korea was vital to U.S. national security interests - seen most visibly by the U.S. military presence on the DMZ - and Thailand and Indonesia were not, or not so much. Korea could not be allowed to fail. The bailout was arranged along two lines, the first concerning the IMF negotiations with the Korean government, the second regarding pressure from the Federal Reserve, Bank of England, Bundesbank and others to persuade the international banking community to roll over short-term foreign currency debts, allowing the Korean government the time theoretically to fill the gap through new debt issues.
For Korea, the avoidance of default in December 1997 had been a very close run thing indeed. The New York Fed has summoned senior officials of the 6 largest banks to its Liberty Street headquarters for a meeting on the Korean situation. Korea was experiencing net outflows of over USD1 billion a day and its usual foreign exchange reserves were not much more than USD5 billion. The banks were encouraged to maintain credit lines to Korea on the view that it was in their own interest given that a Korean default would pose systemic risk to the global financial system. The banks’ agreement on this and subsequent agreement by UK and Europe provided Korea with the necessary, though brief breathing space in which to seek options for funding itself, stopping the outflows and boosting reserves.
The devaluation of the Korean won from around 800 to the dollar to a record low of 1985 had meant the amount of won needed to repay dollar debt had more than doubled and given that just under USD30 billion in short-term debt was due by the end of March 1998, this meant potential bankruptcy without outside aid. Korean corporate foreign currency debt from the top 30 chaebol and their numerous affiliates amounted to around USD60 billion. Following the foreign banks’ agreement to maintain credit lines, the Korean parliament in the first week of January passed the government’s proposal to extend some USD20 billion in government guarantees and to issue a total of USD10 billion in new debt. In late January it was announced that the Korean banks and a group of 13 leading international banks had agreed to extend the maturities of almost USD25 billion in short-term debts to the Korean banks, a further major step in the stabilisation of Korea.
On the Korean side, at one and the same time, the Koreans treated the crisis much like any other crisis of their history, as a national struggle for survival, and simultaneously as an opportunity for more hard-bargaining. On the edge of a financial precipice Korea might be, but its new government under President Kim Dae-jung was not without skill or guile in seeking to obtain more favourable terms. Kim was particularly well aware of the country’s need for new international private finance. One of his first acts as President was to invite George Soros, founder and head of the Soros Fund management, for a private meeting. In a press briefing afterwards, Soros reportedly said that he was seeking to increase significantly” the investment of his lead fund, the Quantum Fund, in Korean asset markets, though he first wanted to see significant corporate restructuring - which would inevitably result in painful but necessary heavy layoffs - greater corporate balance sheet transparency through the consolidation of accounts and labour market flexibility.3 ‘Ihat statement worked wonders for improving Kim Dae-jung’s reputation as a free-market reformer, and at the same time potentially attracting the interest of other Western institutional investors to the country. It was a masterstroke. Kim went further, reintroducing the concept of anonymous bank accounts which his predecessor had banned. The initial ban had caused discreet and black money to flee the country, putting pressure on the currency and interest rate markets. In opening up the economy to foreign ownership, while simultaneously promoting Korean national interests, Kim had to walk a tightrope. It was a high-wire act done with consummate skill, but not without compromise. A reformer he was - and is - but he was not about to tear down the structure, the very fabric of Korean corporate or political society. Kim’s other major success was in getting the unions, militant and moderate alike to agree to mass layoffs in return for unemployment pay, a concept inconceivable under previous Korean administrations.
Yet, while he led the reform element in the hope of attracting the necessary foreign capital to keep the economy and the financial system afloat, not all elements within Korea supported his efforts. The ruling party prior to Kim, which now formed a majority in the national Assembly did not appreciate seeing its corporate allies of long year forcibly restructured or rendered bankrupt and sought to frustrate the restucturing process through stalling bills in the parliament. Equally, the chaebol themselves, having gorged for years on cheap credit were hardly keen to go on a forced diet which in many cases involved the forced sale or liquidation of many of their own affiliates and subsidiaries. Many did not fulfil their part of Kim’s compact with the unions by paying unemployment pay, either because they wouldn’t or because they couldn’t meet such obligations. Meanwhile, the economic cost of the fiscal belt tightening which the IME demanded continued to bite into the soft flesh of the aconomy, hurting healthy and insolvent companies alike.
INDONESIA
The second country to go to the IMF for financial aid, in November of 1997, Indonesia under the leadership of President Soeharto, prevaricated, stalled, delayed, changed and twisted like a chameleon, infuriating IMF officials and Western governments alike. At once accepting the strictures of the initial IMF programme approved by the IMF board on November 5, 1997, Soeharto seemingly reversed course without warning, announcing budgetary measures including the reopening of banks which were shut down supposedly as part of that fiscal rationalisation and which were subsequently re-opened.
The same pattern occurred with the IMF demand for the closure of 16 out of the country’s 260-odd banks. Several of these were to re-open, some simply by virtue of changing their name. This was a further issue which could have been better handled by the IMF given that it played an undoubted part in the complete meltdown of the Indonesian banking system as panicked depositors, unsure of which banks were to be closed, withdrew their funds en masse. The issue is not whether the closure of the 16 banks concerned was correct, but rather that the demand for closure should have been pre-empted by a national guarantee by the Indonesian authorities, with multilateral assistance if necessary, of Indonesian banking deposits. The specific disaster which was visited upon the country’s banking system as a result of this demand need not have happened and the IMF and the Indonesian authorities themselves must share the blame for this.
The IMF made further demands in the latter months of 1997 and early January 1998, more specifically concerning the complete dismantling of the state cartels on primary products, such as palm oil, wood and so forth, and the lifting of subsidies on oil, flour and other basic commodities. In the context of free trade theory, this made perfect sense. Yet applying this theory to the case of Indonesia at the end of 1997 and early 1998 was perhaps not best appropriate. In practice, the dismantling of price and trade controls on palm oil resulted in a massive spike in its price, leading to violent bursts of social unrest from a domestic peasantry, already bemused by mounting job losses. In reaction to this, Soeharto then ordered the banning of palm oil exports, in complete breach of the IMF trade requirements. Soeharto’s dealings with the IMF can best be characterised by a combination of expediency and evasion. Oversight b a Western multilateral organisation such as the IMF was certainly not deemed desirable in the first place, but in the latter months of 1997, when the rupiah was in free-fall and Indonesia’s economy was steadily being destroyed on a daily basis, such oversight - and more to the point, financial aid - was deemed necessary.
Evasion was also necessary, in part because many of the IMF programme demands clashed with the financial and economic interests of the Soeharto family, in part because Soeharto was after all the leader of a nation which had rid itself of colonial domination by the force of arms. It is in this context that the January 15, 1998 signing of the second IMF agreement by Soeharto, seemingly cowering before the erect figure of a grim-faced Michel Camdessus should be seen. To many in Indonesia, this was a humiliating replication of colonisation. For many in the West, this may seem an extreme analogy, but it was not the West which was suffering from its greatest economic catastrophe since the war. A leader of Indonesia who could be so humbled by the West, who could be seen dS so powerless to defend his country’s interests was potentially a leader who was dispensable and expendable. Soeharto came to power in 1966, after all, as a result of a military coup - historical purists will point out here that elements of the military deemed leftists staged a coup against the Sukarno regime, possibly aided by the PKI, the Indonesian Communist Party. There is little question however that the Soeharto faction in the military knew ahead of time of such plans, allowed them to be played out, only to use these as an excuse for a military take-over of the country and a bloody putsch of perceived opposition elements, or more specifically anyone who was thought to be a Communist.
Actions by Asian governments emerging from colonial domination and subsequent internal turmoil cannot be seen exclusive to that historical backdrop, particularly those undertaken by the Soeharto government. It is in this context that we find ourselves on January 20, 1998, with Soeharto stunning the world by announcing the appointment of BJ Habibie as Vice President. At the time, the parliamentary confirmation of this appointment through the MPR was merely a rubber stamp. International reaction was at first bemused and then highly critical. As a minister responsible for national industry and technology, Habibie had been responsible for the creation of a number of industrial projects, including a national aircraft manufacturer, using substantial public investment. He was also responsible for the wholesale acquisition of the (rusting) East German military fleet after the unification of Germany and finally for the economic thought process which many dubbed “Habibienomics”, characterised most clearly by the idea of alternating interest rate loosening and tightening.
Rightly or wrongly, his appointment as Vice President was viewed in the West, in the governments of the U.S. and Europe, and in the IMF, as an unmitigated disaster. Soeharto was showing his hand, that he and he alone was the supreme ruler in Indonesia. Yet, the appointment of Habibie had wider implications. As well as being a champion of national industrial projects (however ill-advised given that most of them lost money), Habibie was also an active promoter of “pribumi” (indigenous Indonesians) and Islamic interests. He was after all head of an important Islamist group, the ICMI (Indonesian Association of Muslim Intellectuals). As such, he had reportedly on occasion openly promoted “pribumi” and Islamic interests over those of the Christian religions and Chinese ethnic minorities. His elevation was thus seen also as an elevation of Islam in the national political psyche, an important departure from the previous government’s policies which had brutally if effectively dealt with any Islamist elements deemed fundamentalist or against the binding national ideology of “pancasila”.
Subsequently, elements of the Indonesian society appeared to see this as a green light for the public promotion of ‘pribumi” interests with some calling for the expropriation or redistribution of ethnic Chinese wealth among the pribumis. What had started as an economic recession was rapidly developing nasty and serious sociopolitical and ethnic overtones. While sporadic rioting outside of Jakarta was gradually taking on an ethnic, anti-Chinese flavour, minorities were initially protected by the security forces in the capital itself. Coincidence? Surely not! It was most likely a graphic demonstration by Soeharto again of who was in charge and the chaos that might ensue if that iron grip on control was ever let slip.
Yet, Soeharto had other tricks up his sleeve, on the economic as well as the political side. In particular, he stumbled upon one trick, the idea of a currency board. It is unknown quite how Soeharto came upon this idea, though it seems doubtful that it originated from his own economic and financial technocracy, particularly since the very concept of a currency board necessitates the theoretical elimination of discretionary control by a country’s central bank over its monetary policy, if not the complete elimination of the central bank itself. For a central bank or a finance ministry to suggest such an idea would be tantamount to suicide. Whatever the case, Soeharto’s discovery” of the idea of a currency board coincided with the public promotion of the same idea by a university professor at John Hopkins University in the U.S., one Stephen Hanke. The IMF programme conditions were not only against the financial interests of the Soeharto Family. The full implementation of liberalisation, the shutting down of debt-ridden corporations and banks and the elimination of price controls were tantamount to a demand for the regime itself to commit political suicide given the social and political backlash which would inevitably result from these policies. Yet, Soeharto undoubtedly needed the significant funds attached to that IMF programme. Hence, he needed to be seen to be willing to go along with the programme, thus attracting initial loan commitments, if not actual disbursements from the programme while at the same time playing for time in terms of applying the terms and conditions of the programme, to avoid the worst consequences of these conditions for the regime itself and at the same time to seek a classical, economic alternative to those conditions.
The currency board idea thus suited Soeharto’s objectives perfectly. Hanke was soon invited to Soeharto’s “court” - given that Soeharto seemed in every respect the modern incarnation of a traditional Javanese King, this analogy seems apposite - where one must presume he discussed the intracacies of the currency board concept with the great man and his hangers-on, and its application to the Indonesian situation.
It must also be presumed that the IMF, which seems to deem itself the economic arbiter of the last resort, is not used to or tolerant of economic alternative ideas, to its stated policy recommendations. Certainly, the IMF public reaction to the currency board idea was far from positive, not only because it was deemed unworkable, but because the very fact of an alternative idea was unwelcome. A currency board requires the subjugation of monetary control to a fixed peg or exchange rate, extreme fiscal discipline, the backing of the monetary base by foreign currency reserves and the national resolve to accept that the economy henceforth takes the pain of adjustment rather than the exchange rate resulting from financial over-valuation. On its own, Indonesia did not have the reserves to back its monetary base commitment to a currency board. In order to do so, it would need extra funds from the international community and the IMP nas at that time ideologically opposed to the idea of a currency board in Indonesia since this ran in direct opposition to its existing policy prescription. Even if it had the necessary funds for this purpose, given the shattered state of its economy and more importantly of its banking sector, the market would most likely test Indonesia’s commitment to a currency board, necessitating initially sharply higher interest rates to defend the currency board peg. Those who argue that Indonesia’s banking system could not under any circumstances have withstood the requirements of a currency board system ignore the precedent of Argentina whose banking system was in similarly perilous state before the implementation of a currency board in 1991 and equally the fact that the discipline of the currency board saved both the economy and the financial system of that country.
So much for theory. There can be little doubt that Indonesia, unlike in the case of Argentina, did not have the resolve to follow through on the currency board idea. When Soeharto learned the requirements of a currency board, he most probably would have dismissed the idea out of hand, albeit privately given that the stratospheric interest rates needed to defend the currency board initially would have caused potentially explosive social unrest. The best that can be said of the currency board idea in Indonesia was that it could have worked theoretically if the government had had the unswerving resolve to implement it fully, but in the end Soeharto rejected the idea for very practical reasons. In the meantime, however, Soeharto pretended to continue to consider the idea. This served two useful purposes. On the one hand, it kept the IMF occupied, and away from demanding the implementation of their own programme conditions. On the other, it had the hitherto unexpected benefit of causing the Indonesian rupiah to stabilise and even strengthen. The rupicth had by that time hit a distant and record low of 17,000 to the dollar (as against around 2,400 before the devaluation), only to slowly crawl its way back from that abyss after the signing of the second IMF agreement. At a time when it was still trading around 12,000 to the dollar, official leaks suggested that a currency board might be implemented at between 5,000-8,000 to the dollar, immediately causing currency traders to cover short rupiah, long dollar positions, by buying back the rupiah, just in case such a seemingly far fetched idea was actually implemented. This provided at least some degree of platform for economic stabilisation while Soeharto tried to keep the IMF at bay.
While the Western media speculated that Soeharto might actually implement a currency board at an exchange rate of 5,000 to the dollar, as per official leaks, in order to bail out much of the Indonesian corporate base linked to the First Family - a policy which would have seemed eminently reasonable on the face of it to a javanese King - it seems likely that Soeharto, at least in the latter stages after he had been made to understand its implications, had no intention whatsoever of actually implementing a currency board given the likely consequences to the banking system and the country as a result of yet higher interest rates. Soeharto was thus, yet again, the Javanese puppet master in an elaborate puppet game. Neither Hanke nor Soeharto were to remain unscathed from this episode. In the case of the former, he was publicly castigated by many commentators, most famously by the MIT Professor Paul Krugman as the “rupiah Rasputin”, a description seemingly aimed more at capturing the media’s headlines rather than adding to the level of economic debate.
Meanwhile. Soeharto continued to court alternatives to the IMF In March 1998, Habibie toured Japan, pleading for financial aid. The then Japanese Prime Minister Hashimoto followed this up with a visit to Jakarta in April, bringing commitments of financial and food aid, notably of basic commodities such as rice. Japan had a major vested interest in not allowing Indonesia to go under since its banks were thought to be exposed in Indonesia to the tune of USD24 billion. Japan’s trading houses were thought to be even more exposed than their Japanese banking counterparts. Japan’s commitment to helping Asia up until then had met with significant controversy. In mid-1997, it had proposed an idea subsequently to be dubbed an Asian Monetary Fund, reflecting a reserve facility upon which Asian authorities could draw in times of need. This idea had gone down like a lead balloon in Washington, publicly because there was no need to replace the existing facilities of the IMF, and privately because it represented a fundamental challenge to U.S. dominance of the global financial system. Japan’s loans to Indonesia and Thailand and the subsequent Miyazawa Initiative, named after Finance Minister Kiichi Miyazawa and reflective of this initial idea of a Japanese-dominated and created loan fund for Asian countries in need, were controversial with Western governments because they too represented a key challenge to Western domination in Asia. Yet, they were surely reflective merely of what the West had long since demanded, namely a more assertive Japanese presence on the world’s political and financial stage.
Japan’s loans were the catalyst for donations from other Asian countries, but though they delayed the IMP’s demands on Indonesia, they did not serve to deflect them. The IMF continued to demand its trademark brand of fiscal and monetary austerity coupled with market opening and supervisory regulations. Without these, IMF loan commitments would not become actual disbursements. Soeharto’s delaying tactics had frustrated and fooled many, but they did nothing to solve the underlying problem. The Indonesian corporate base was to all intents and purposes completely bankrupt, its banking system in tatters. Unemployed urban workers were being herded into trucks by the military in order to avoid major public demonstrations or unrest. Soeharto faced two alternatives, both potentially unpalatable. One was to give in completely to the IMF demands and thus risk complete social and political disintegration and more importantly his own removal. The other was not to give in and to continue to delay, thus getting IMF and international loan commitments but few actual disbursements. The country would thus continue to stagnate, more companies would continue to go bankrupt. In the end, Soeharto seems to have chosen a combination of going down fighting, while protecting his own.
In this regard, Soeharto’s last hurrah was his move on May 5, as he left for an emerging market summit in Cairo, to eliminate all price controls on basic commodities for a year which he had up until then been delaying on the view that such price control elimination would be socially disastrous. The result should have been predictable. Within a week, Jakarta’s Chinatown district was in flames as the city’s primarily Muslim disadvantaged used the perceived wealthier ethnic Chinese Indonesians as the scapegoats of their own misfortune. At the time, several newswires reported the suspicion that elements of Indonesia’s special forces, then under the command of Soeharto’s son-in-law Lieutenant General Prabowo, were responsible for fuelling and inciting the riots which wracked Jakarta in May of 1998, involving the killing and raping of ethnic Chinese. Subsequently, an Indonesian military court ruling confirmed this reported suspicion. In total, around 1,120 people died in the May riots, including several hundred looters who perished in a building which they were in the process of looting and which was mysteriously set on fire. Subsequently theories abounded that Prabowo had been attempting a coup while Soeharto was away. This view - denied by Prabowo - gained prominence because ABRI (Armed Forces of Indonesia) Commander General Wiranto was also away from Jakarta at the time. Whatever the case, Wiranto returned and restored order to the streets of Jakarta through a combination of stern orders that looters would be shot on sight, and attempts to negotiate with demonstrators and student groups. When Soeharto returned to Jakarta, his capital was effectively under martial law. Once more, he had demonstrated that he - and by implication the military from which he came - were “the only game in town”. Yet again, he had “proved” himself indispensable to the West (i.e. the IMF) in keeping Indonesia in one piece. Yet, the underlying fundamental condition of Indonesia continued to worsen. Indeed, that degree of deterioration had just been multiplied several times over as a result of the May riots. The essential calamity which was destroying the very fabric of Indonesian society, let alone its economy, could not be outrun by Soeharto’s delaying tactics.
On May 17, Soeharto had claimed emergency powers from the MPR, only for House Speaker Harmoko to call for Soeharto’s resignation the following day. Daily student demonstrations climaxed in the storming of the parliament itself. ABRI Commander General Wiranto had plenty of opportunity to shed significant blood if he had wanted to, but instead he seemed reluctant to fight such public expression of discontent through force of arms on the streets of the capital.
The bottom line had been that Indonesia, its fiscal and current accounts badly holed below the water line was sinking fast and needed money immediately to plug the gaps. With Soeharto in power, Indonesia was unlikely to get it. This realisation now coincided with widespread public demands for Soeharto’s resignation. On May 20, the unthinkable happened. Soeharto stood before the world’s media and announced his resignation, handing over to his Vice President BJ Habibie. The Western media recounted the end of a 32-year reign, as if the old man, now stripped of formal office, was also stripped of all influence. This was very far from the truth and to many a case of wishful thinking. Habibie was after all like an adopted son to Soeharto, dating back to the time when Soeharto as a young army officer had stayed at the Habibie home in the outer islands. Despite having his own financial resources, Habibie owed his elevation in government circles almost entirely to his “father” figure. To then say that Habibie mounted a coup against Soeharto is thus nonsense. General Wiranto almost let slip the reality when he stated publicly that no member of the Soeharto Family nor their assets would be allowed to come to harm, this while the houses of rich ethnic Chinese who had done much to finance the regime were allowed to be ransacked and burned, It is in this context that the initial elevation of Habibie to Vice President should be seen. Yes, he was put in place as a transition President, but also one who would protect the interests of his “father” Soeharto, either deliberately or otherwise. In the Javanese puppet game, Habibie played his part, an important part to be sure, but the puppet-master had not changed. Soeharto still pulled the strings. To be sure, there had to be sacrifices, examples which could be held as proving the new administration’s reforming spirit. Right after Habibie was handed the reigns of power (subsequently to be confirmed by a vote of parliament), he removed from ministerial office ‘Bob” Hasan, Soeharto’s golfing partner, and “Tutut”, his daughter, a very public gesture of reducing the influence of the First Family. While filling technocratic positions with his own supporters, Habibie did everything possible in the public arena to please the U.S. administration and the IMF, promising free and fair elections the following year. He made the Bank of Indonesia separate and independent from the government by an act of parliament. He supervised the setting up of the Indonesian Banking Restructuring Agency and the Indonesian Debt Restructuring Agency. Western officials must have been pleasantly surprised. Certainly, the markets were. In truth, however, little had changed. Soeharto still held considerable influence, if only by his sheer presence and force of personality. The interests of his family had not been realistically threatened let alone expropriated. Meanwhile, the economy continued to deteriorate, the debt burden to get ever larger.
The first effort in Tokyo in May 1998 to restructure and rollover foreign bank loans to the domestic banking system had seen its talks come to nothing. Subsequently, in June of that year in Frankfurt, an agreement was tentatively reached with Indonesia’s leading creditors, allowing a 3-5 year grace period for the repayment of the principal. Indonesian Debt Restructuring Agency (INDRA) was set up to provide foreign currency, though in a crucial departure from the Mexico 1982 bailout INDRA did not guarantee to subsidise the translation exchange rate to be used for debt restructuring. There was thus little incentive for an Indonesian corporation or bank to use INDRA.
The same pattern occurred with the IMF demand for the closure of 16 out of the country’s 260-odd banks. Several of these were to re-open, some simply by virtue of changing their name. This was a further issue which could have been better handled by the IMF given that it played an undoubted part in the complete meltdown of the Indonesian banking system as panicked depositors, unsure of which banks were to be closed, withdrew their funds en masse. The issue is not whether the closure of the 16 banks concerned was correct, but rather that the demand for closure should have been pre-empted by a national guarantee by the Indonesian authorities, with multilateral assistance if necessary, of Indonesian banking deposits. The specific disaster which was visited upon the country’s banking system as a result of this demand need not have happened and the IMF and the Indonesian authorities themselves must share the blame for this.
The IMF made further demands in the latter months of 1997 and early January 1998, more specifically concerning the complete dismantling of the state cartels on primary products, such as palm oil, wood and so forth, and the lifting of subsidies on oil, flour and other basic commodities. In the context of free trade theory, this made perfect sense. Yet applying this theory to the case of Indonesia at the end of 1997 and early 1998 was perhaps not best appropriate. In practice, the dismantling of price and trade controls on palm oil resulted in a massive spike in its price, leading to violent bursts of social unrest from a domestic peasantry, already bemused by mounting job losses. In reaction to this, Soeharto then ordered the banning of palm oil exports, in complete breach of the IMF trade requirements. Soeharto’s dealings with the IMF can best be characterised by a combination of expediency and evasion. Oversight b a Western multilateral organisation such as the IMF was certainly not deemed desirable in the first place, but in the latter months of 1997, when the rupiah was in free-fall and Indonesia’s economy was steadily being destroyed on a daily basis, such oversight - and more to the point, financial aid - was deemed necessary.
Evasion was also necessary, in part because many of the IMF programme demands clashed with the financial and economic interests of the Soeharto family, in part because Soeharto was after all the leader of a nation which had rid itself of colonial domination by the force of arms. It is in this context that the January 15, 1998 signing of the second IMF agreement by Soeharto, seemingly cowering before the erect figure of a grim-faced Michel Camdessus should be seen. To many in Indonesia, this was a humiliating replication of colonisation. For many in the West, this may seem an extreme analogy, but it was not the West which was suffering from its greatest economic catastrophe since the war. A leader of Indonesia who could be so humbled by the West, who could be seen dS so powerless to defend his country’s interests was potentially a leader who was dispensable and expendable. Soeharto came to power in 1966, after all, as a result of a military coup - historical purists will point out here that elements of the military deemed leftists staged a coup against the Sukarno regime, possibly aided by the PKI, the Indonesian Communist Party. There is little question however that the Soeharto faction in the military knew ahead of time of such plans, allowed them to be played out, only to use these as an excuse for a military take-over of the country and a bloody putsch of perceived opposition elements, or more specifically anyone who was thought to be a Communist.
Actions by Asian governments emerging from colonial domination and subsequent internal turmoil cannot be seen exclusive to that historical backdrop, particularly those undertaken by the Soeharto government. It is in this context that we find ourselves on January 20, 1998, with Soeharto stunning the world by announcing the appointment of BJ Habibie as Vice President. At the time, the parliamentary confirmation of this appointment through the MPR was merely a rubber stamp. International reaction was at first bemused and then highly critical. As a minister responsible for national industry and technology, Habibie had been responsible for the creation of a number of industrial projects, including a national aircraft manufacturer, using substantial public investment. He was also responsible for the wholesale acquisition of the (rusting) East German military fleet after the unification of Germany and finally for the economic thought process which many dubbed “Habibienomics”, characterised most clearly by the idea of alternating interest rate loosening and tightening.
Rightly or wrongly, his appointment as Vice President was viewed in the West, in the governments of the U.S. and Europe, and in the IMF, as an unmitigated disaster. Soeharto was showing his hand, that he and he alone was the supreme ruler in Indonesia. Yet, the appointment of Habibie had wider implications. As well as being a champion of national industrial projects (however ill-advised given that most of them lost money), Habibie was also an active promoter of “pribumi” (indigenous Indonesians) and Islamic interests. He was after all head of an important Islamist group, the ICMI (Indonesian Association of Muslim Intellectuals). As such, he had reportedly on occasion openly promoted “pribumi” and Islamic interests over those of the Christian religions and Chinese ethnic minorities. His elevation was thus seen also as an elevation of Islam in the national political psyche, an important departure from the previous government’s policies which had brutally if effectively dealt with any Islamist elements deemed fundamentalist or against the binding national ideology of “pancasila”.
Subsequently, elements of the Indonesian society appeared to see this as a green light for the public promotion of ‘pribumi” interests with some calling for the expropriation or redistribution of ethnic Chinese wealth among the pribumis. What had started as an economic recession was rapidly developing nasty and serious sociopolitical and ethnic overtones. While sporadic rioting outside of Jakarta was gradually taking on an ethnic, anti-Chinese flavour, minorities were initially protected by the security forces in the capital itself. Coincidence? Surely not! It was most likely a graphic demonstration by Soeharto again of who was in charge and the chaos that might ensue if that iron grip on control was ever let slip.
Yet, Soeharto had other tricks up his sleeve, on the economic as well as the political side. In particular, he stumbled upon one trick, the idea of a currency board. It is unknown quite how Soeharto came upon this idea, though it seems doubtful that it originated from his own economic and financial technocracy, particularly since the very concept of a currency board necessitates the theoretical elimination of discretionary control by a country’s central bank over its monetary policy, if not the complete elimination of the central bank itself. For a central bank or a finance ministry to suggest such an idea would be tantamount to suicide. Whatever the case, Soeharto’s discovery” of the idea of a currency board coincided with the public promotion of the same idea by a university professor at John Hopkins University in the U.S., one Stephen Hanke. The IMF programme conditions were not only against the financial interests of the Soeharto Family. The full implementation of liberalisation, the shutting down of debt-ridden corporations and banks and the elimination of price controls were tantamount to a demand for the regime itself to commit political suicide given the social and political backlash which would inevitably result from these policies. Yet, Soeharto undoubtedly needed the significant funds attached to that IMF programme. Hence, he needed to be seen to be willing to go along with the programme, thus attracting initial loan commitments, if not actual disbursements from the programme while at the same time playing for time in terms of applying the terms and conditions of the programme, to avoid the worst consequences of these conditions for the regime itself and at the same time to seek a classical, economic alternative to those conditions.
The currency board idea thus suited Soeharto’s objectives perfectly. Hanke was soon invited to Soeharto’s “court” - given that Soeharto seemed in every respect the modern incarnation of a traditional Javanese King, this analogy seems apposite - where one must presume he discussed the intracacies of the currency board concept with the great man and his hangers-on, and its application to the Indonesian situation.
It must also be presumed that the IMF, which seems to deem itself the economic arbiter of the last resort, is not used to or tolerant of economic alternative ideas, to its stated policy recommendations. Certainly, the IMF public reaction to the currency board idea was far from positive, not only because it was deemed unworkable, but because the very fact of an alternative idea was unwelcome. A currency board requires the subjugation of monetary control to a fixed peg or exchange rate, extreme fiscal discipline, the backing of the monetary base by foreign currency reserves and the national resolve to accept that the economy henceforth takes the pain of adjustment rather than the exchange rate resulting from financial over-valuation. On its own, Indonesia did not have the reserves to back its monetary base commitment to a currency board. In order to do so, it would need extra funds from the international community and the IMP nas at that time ideologically opposed to the idea of a currency board in Indonesia since this ran in direct opposition to its existing policy prescription. Even if it had the necessary funds for this purpose, given the shattered state of its economy and more importantly of its banking sector, the market would most likely test Indonesia’s commitment to a currency board, necessitating initially sharply higher interest rates to defend the currency board peg. Those who argue that Indonesia’s banking system could not under any circumstances have withstood the requirements of a currency board system ignore the precedent of Argentina whose banking system was in similarly perilous state before the implementation of a currency board in 1991 and equally the fact that the discipline of the currency board saved both the economy and the financial system of that country.
So much for theory. There can be little doubt that Indonesia, unlike in the case of Argentina, did not have the resolve to follow through on the currency board idea. When Soeharto learned the requirements of a currency board, he most probably would have dismissed the idea out of hand, albeit privately given that the stratospheric interest rates needed to defend the currency board initially would have caused potentially explosive social unrest. The best that can be said of the currency board idea in Indonesia was that it could have worked theoretically if the government had had the unswerving resolve to implement it fully, but in the end Soeharto rejected the idea for very practical reasons. In the meantime, however, Soeharto pretended to continue to consider the idea. This served two useful purposes. On the one hand, it kept the IMF occupied, and away from demanding the implementation of their own programme conditions. On the other, it had the hitherto unexpected benefit of causing the Indonesian rupiah to stabilise and even strengthen. The rupicth had by that time hit a distant and record low of 17,000 to the dollar (as against around 2,400 before the devaluation), only to slowly crawl its way back from that abyss after the signing of the second IMF agreement. At a time when it was still trading around 12,000 to the dollar, official leaks suggested that a currency board might be implemented at between 5,000-8,000 to the dollar, immediately causing currency traders to cover short rupiah, long dollar positions, by buying back the rupiah, just in case such a seemingly far fetched idea was actually implemented. This provided at least some degree of platform for economic stabilisation while Soeharto tried to keep the IMF at bay.
While the Western media speculated that Soeharto might actually implement a currency board at an exchange rate of 5,000 to the dollar, as per official leaks, in order to bail out much of the Indonesian corporate base linked to the First Family - a policy which would have seemed eminently reasonable on the face of it to a javanese King - it seems likely that Soeharto, at least in the latter stages after he had been made to understand its implications, had no intention whatsoever of actually implementing a currency board given the likely consequences to the banking system and the country as a result of yet higher interest rates. Soeharto was thus, yet again, the Javanese puppet master in an elaborate puppet game. Neither Hanke nor Soeharto were to remain unscathed from this episode. In the case of the former, he was publicly castigated by many commentators, most famously by the MIT Professor Paul Krugman as the “rupiah Rasputin”, a description seemingly aimed more at capturing the media’s headlines rather than adding to the level of economic debate.
Meanwhile. Soeharto continued to court alternatives to the IMF In March 1998, Habibie toured Japan, pleading for financial aid. The then Japanese Prime Minister Hashimoto followed this up with a visit to Jakarta in April, bringing commitments of financial and food aid, notably of basic commodities such as rice. Japan had a major vested interest in not allowing Indonesia to go under since its banks were thought to be exposed in Indonesia to the tune of USD24 billion. Japan’s trading houses were thought to be even more exposed than their Japanese banking counterparts. Japan’s commitment to helping Asia up until then had met with significant controversy. In mid-1997, it had proposed an idea subsequently to be dubbed an Asian Monetary Fund, reflecting a reserve facility upon which Asian authorities could draw in times of need. This idea had gone down like a lead balloon in Washington, publicly because there was no need to replace the existing facilities of the IMF, and privately because it represented a fundamental challenge to U.S. dominance of the global financial system. Japan’s loans to Indonesia and Thailand and the subsequent Miyazawa Initiative, named after Finance Minister Kiichi Miyazawa and reflective of this initial idea of a Japanese-dominated and created loan fund for Asian countries in need, were controversial with Western governments because they too represented a key challenge to Western domination in Asia. Yet, they were surely reflective merely of what the West had long since demanded, namely a more assertive Japanese presence on the world’s political and financial stage.
Japan’s loans were the catalyst for donations from other Asian countries, but though they delayed the IMP’s demands on Indonesia, they did not serve to deflect them. The IMF continued to demand its trademark brand of fiscal and monetary austerity coupled with market opening and supervisory regulations. Without these, IMF loan commitments would not become actual disbursements. Soeharto’s delaying tactics had frustrated and fooled many, but they did nothing to solve the underlying problem. The Indonesian corporate base was to all intents and purposes completely bankrupt, its banking system in tatters. Unemployed urban workers were being herded into trucks by the military in order to avoid major public demonstrations or unrest. Soeharto faced two alternatives, both potentially unpalatable. One was to give in completely to the IMF demands and thus risk complete social and political disintegration and more importantly his own removal. The other was not to give in and to continue to delay, thus getting IMF and international loan commitments but few actual disbursements. The country would thus continue to stagnate, more companies would continue to go bankrupt. In the end, Soeharto seems to have chosen a combination of going down fighting, while protecting his own.
In this regard, Soeharto’s last hurrah was his move on May 5, as he left for an emerging market summit in Cairo, to eliminate all price controls on basic commodities for a year which he had up until then been delaying on the view that such price control elimination would be socially disastrous. The result should have been predictable. Within a week, Jakarta’s Chinatown district was in flames as the city’s primarily Muslim disadvantaged used the perceived wealthier ethnic Chinese Indonesians as the scapegoats of their own misfortune. At the time, several newswires reported the suspicion that elements of Indonesia’s special forces, then under the command of Soeharto’s son-in-law Lieutenant General Prabowo, were responsible for fuelling and inciting the riots which wracked Jakarta in May of 1998, involving the killing and raping of ethnic Chinese. Subsequently, an Indonesian military court ruling confirmed this reported suspicion. In total, around 1,120 people died in the May riots, including several hundred looters who perished in a building which they were in the process of looting and which was mysteriously set on fire. Subsequently theories abounded that Prabowo had been attempting a coup while Soeharto was away. This view - denied by Prabowo - gained prominence because ABRI (Armed Forces of Indonesia) Commander General Wiranto was also away from Jakarta at the time. Whatever the case, Wiranto returned and restored order to the streets of Jakarta through a combination of stern orders that looters would be shot on sight, and attempts to negotiate with demonstrators and student groups. When Soeharto returned to Jakarta, his capital was effectively under martial law. Once more, he had demonstrated that he - and by implication the military from which he came - were “the only game in town”. Yet again, he had “proved” himself indispensable to the West (i.e. the IMF) in keeping Indonesia in one piece. Yet, the underlying fundamental condition of Indonesia continued to worsen. Indeed, that degree of deterioration had just been multiplied several times over as a result of the May riots. The essential calamity which was destroying the very fabric of Indonesian society, let alone its economy, could not be outrun by Soeharto’s delaying tactics.
On May 17, Soeharto had claimed emergency powers from the MPR, only for House Speaker Harmoko to call for Soeharto’s resignation the following day. Daily student demonstrations climaxed in the storming of the parliament itself. ABRI Commander General Wiranto had plenty of opportunity to shed significant blood if he had wanted to, but instead he seemed reluctant to fight such public expression of discontent through force of arms on the streets of the capital.
The bottom line had been that Indonesia, its fiscal and current accounts badly holed below the water line was sinking fast and needed money immediately to plug the gaps. With Soeharto in power, Indonesia was unlikely to get it. This realisation now coincided with widespread public demands for Soeharto’s resignation. On May 20, the unthinkable happened. Soeharto stood before the world’s media and announced his resignation, handing over to his Vice President BJ Habibie. The Western media recounted the end of a 32-year reign, as if the old man, now stripped of formal office, was also stripped of all influence. This was very far from the truth and to many a case of wishful thinking. Habibie was after all like an adopted son to Soeharto, dating back to the time when Soeharto as a young army officer had stayed at the Habibie home in the outer islands. Despite having his own financial resources, Habibie owed his elevation in government circles almost entirely to his “father” figure. To then say that Habibie mounted a coup against Soeharto is thus nonsense. General Wiranto almost let slip the reality when he stated publicly that no member of the Soeharto Family nor their assets would be allowed to come to harm, this while the houses of rich ethnic Chinese who had done much to finance the regime were allowed to be ransacked and burned, It is in this context that the initial elevation of Habibie to Vice President should be seen. Yes, he was put in place as a transition President, but also one who would protect the interests of his “father” Soeharto, either deliberately or otherwise. In the Javanese puppet game, Habibie played his part, an important part to be sure, but the puppet-master had not changed. Soeharto still pulled the strings. To be sure, there had to be sacrifices, examples which could be held as proving the new administration’s reforming spirit. Right after Habibie was handed the reigns of power (subsequently to be confirmed by a vote of parliament), he removed from ministerial office ‘Bob” Hasan, Soeharto’s golfing partner, and “Tutut”, his daughter, a very public gesture of reducing the influence of the First Family. While filling technocratic positions with his own supporters, Habibie did everything possible in the public arena to please the U.S. administration and the IMF, promising free and fair elections the following year. He made the Bank of Indonesia separate and independent from the government by an act of parliament. He supervised the setting up of the Indonesian Banking Restructuring Agency and the Indonesian Debt Restructuring Agency. Western officials must have been pleasantly surprised. Certainly, the markets were. In truth, however, little had changed. Soeharto still held considerable influence, if only by his sheer presence and force of personality. The interests of his family had not been realistically threatened let alone expropriated. Meanwhile, the economy continued to deteriorate, the debt burden to get ever larger.
The first effort in Tokyo in May 1998 to restructure and rollover foreign bank loans to the domestic banking system had seen its talks come to nothing. Subsequently, in June of that year in Frankfurt, an agreement was tentatively reached with Indonesia’s leading creditors, allowing a 3-5 year grace period for the repayment of the principal. Indonesian Debt Restructuring Agency (INDRA) was set up to provide foreign currency, though in a crucial departure from the Mexico 1982 bailout INDRA did not guarantee to subsidise the translation exchange rate to be used for debt restructuring. There was thus little incentive for an Indonesian corporation or bank to use INDRA.
THAILAND
Returning to the example of Thailand, whatever the theory, the Thai government set about in a decidedly practical fashion to follow the IMF polic prescription to the letter. Taxes were raised and spending programmes were savaged. Shortly after the initial devaluation of the baht, the Thai government increased the ceiling for foreign ownership in Thai corporations from 2S to 10000. Along with the fiscal strait jacket which it applied, the Thai authorities, albeit with some reluctance, closed down 56 finance companies which had found themselves over-exposed to the domestic property sector in the wake of the asset market crash which took place before and after the devaluation of the bout. Subsequently, the authorities allowed foreigners to own a majority stake in the 56 finance companies - if anyone wanted to
There can be no question that the Thai authorities applied the terms of their bailout package with the IMF most rigorously and fully. Indeed, such was the determination of Thailand to take the medicine given to it, however bitter, that it did not shirk the cost, and the cost was high. Indeed, in addition to the middle classes and Northern peasants demonstrating in the streets of Bangkok, in addition to what one commentator called the decapitation” of the Thai middle classes, the bankruptcies, the hundreds of thousands who lost their jobs and were forced into poverty, it cost the very existence of the Thai government itself. New coalitions were formed and once the presence of the Chavalit government had been removed, Chuan
Leepkai of the Democrats returned to power. This caused jubilation and hope among offshore markets, though some investors with long memories would recall that it was the same Chuan Leepkai who as part of his programme of financial liberalisation created the BIBF, the well-spring of so much of the short-term dollar debt and therefore of the resulting financial chaos in the first place.
Still, with Thai asset markets seemingly being priced at bargain- basement value, one or two foreign investors started to return, started to sift through the rubble of shattered balance sheets for occasional gems. Thailand saw a contraction in 1997 of -1.3 only for this to increase dramatically to -9.4 in 1998 as the initial government programme of fiscal rationalisation and monetary tightening added to the collapse in domestic demand resulting from the currency devaluation. As a consequence, the external gap was more than closed, indeed Thailand produced substantial trade and current account surpluses for 1998. The cost of that was the domestic economy, but in large part that was precisely the aim of the IMF programme. The domestic economy had to bear the brunt of the adjustment in order for the current account deficit to be reduced and ultimately eliminated. At the macroeconomic level, that swing in the Thai current account balance to a surplus of 12.8 of GDP in 1998 from a deficit of -2.1 in 1997 and -7.9 in 1996 represented a healthy improvement in medium-term fundamentals, albeit at the expense, temporarily of the domestic consumer. Left at that, things would have been fine. The economy would have gradually recovered by itself. Yet, the degree of current account surplus in 1998 and equally the degree of economic growth contraction betrayed deeper ills that might otherwise be solved by such general, sweeping macroeconomic measures. At the microeconomic level, the deterioration of the Thai balit and the consequent revaluation of dollar debts had eviscerated most Thai corporate and banking balance sheets, bringing low even renowned Thai conglomerates or at the very least burdening them with massive foreign exchange losses.
With the Thai banking system saddled with bad debts of 400o of total and rising, local banks were neither able nor willing to lend to the corporate base or to consumers. Instead, they sought first to seek to repair their own shattered balance sheets by buying up every long- dated government bond issue they could find at auction and in turn borrowing the funds for those purchases from the bank of Thailand through its repo window, thus making the spread between those two interest rates. The fiscal side was being tightened, interest rates were being kept high in order to support the weakened currency and in addition banks were showing no willingness to lend whatsoever.
From a financial crisis, Thailand had been thrown into a deep economic recession, verging on outright depression. Meanwhile, if it were possible, the situation in Indonesia was even worse.
There can be no question that the Thai authorities applied the terms of their bailout package with the IMF most rigorously and fully. Indeed, such was the determination of Thailand to take the medicine given to it, however bitter, that it did not shirk the cost, and the cost was high. Indeed, in addition to the middle classes and Northern peasants demonstrating in the streets of Bangkok, in addition to what one commentator called the decapitation” of the Thai middle classes, the bankruptcies, the hundreds of thousands who lost their jobs and were forced into poverty, it cost the very existence of the Thai government itself. New coalitions were formed and once the presence of the Chavalit government had been removed, Chuan
Leepkai of the Democrats returned to power. This caused jubilation and hope among offshore markets, though some investors with long memories would recall that it was the same Chuan Leepkai who as part of his programme of financial liberalisation created the BIBF, the well-spring of so much of the short-term dollar debt and therefore of the resulting financial chaos in the first place.
Still, with Thai asset markets seemingly being priced at bargain- basement value, one or two foreign investors started to return, started to sift through the rubble of shattered balance sheets for occasional gems. Thailand saw a contraction in 1997 of -1.3 only for this to increase dramatically to -9.4 in 1998 as the initial government programme of fiscal rationalisation and monetary tightening added to the collapse in domestic demand resulting from the currency devaluation. As a consequence, the external gap was more than closed, indeed Thailand produced substantial trade and current account surpluses for 1998. The cost of that was the domestic economy, but in large part that was precisely the aim of the IMF programme. The domestic economy had to bear the brunt of the adjustment in order for the current account deficit to be reduced and ultimately eliminated. At the macroeconomic level, that swing in the Thai current account balance to a surplus of 12.8 of GDP in 1998 from a deficit of -2.1 in 1997 and -7.9 in 1996 represented a healthy improvement in medium-term fundamentals, albeit at the expense, temporarily of the domestic consumer. Left at that, things would have been fine. The economy would have gradually recovered by itself. Yet, the degree of current account surplus in 1998 and equally the degree of economic growth contraction betrayed deeper ills that might otherwise be solved by such general, sweeping macroeconomic measures. At the microeconomic level, the deterioration of the Thai balit and the consequent revaluation of dollar debts had eviscerated most Thai corporate and banking balance sheets, bringing low even renowned Thai conglomerates or at the very least burdening them with massive foreign exchange losses.
With the Thai banking system saddled with bad debts of 400o of total and rising, local banks were neither able nor willing to lend to the corporate base or to consumers. Instead, they sought first to seek to repair their own shattered balance sheets by buying up every long- dated government bond issue they could find at auction and in turn borrowing the funds for those purchases from the bank of Thailand through its repo window, thus making the spread between those two interest rates. The fiscal side was being tightened, interest rates were being kept high in order to support the weakened currency and in addition banks were showing no willingness to lend whatsoever.
From a financial crisis, Thailand had been thrown into a deep economic recession, verging on outright depression. Meanwhile, if it were possible, the situation in Indonesia was even worse.
วันอาทิตย์ที่ 1 สิงหาคม พ.ศ. 2553
Debt for Debt: 'Financing the American Family' (Into Oblivion?)
THE QUESTION OF APPROPRIATE IMF POLICY RESPONSE
The IMF itself responded to the criticisms it received for its programme focus in several reports, notably in “The IMF’s Response to the Asian Crisis” (January 17, 1999) which gave a preliminary assessment of its programmes for Indonesia, Korea and Thailand, for the most part defending its actions although it admitted that lessons had been learned during the crisis. In the case of the Asian crisis, the IMF saw its role primarily remaining in the defence and safety of the global financial system, and secondly helping to restore confidence to the economies affected by the crisis. Its goal was thus to provide financial programmes which might provide the foundation for economic stabilisation - and this is indeed exactly what it did. The pillars of this platform were consequently:
1. Temporary monetary tightening to stop exchange rate depreciation
2. Concerted action to correct the weaknesses in the financial system, which contributed significantly to the crisis
3. Structural reforms to remove features of the economy that had become impediments to growth (such as monopolies, trade barriers, and nontransparent corporate practices) and to improve the efficiency of financial inter-mediation and the future soundness of financial systems
4. Efforts to assist in reopening or maintaining lines of external financing
3. The maintenance of a sound fiscal policy, including through providing for rising budgetary costs of financial sector restructuring, while protecting social spending. Once the severity of the economic downturn in the affected countries became clear, fiscal policy was oriented toward supporting economic activity and expanding the social sector safety net.’
It was consequently NOT the IMF’s specific job to attempt or help with the stabilisation of the financial markets through the implementation of short-term measures, which could well prove contrary to the medium-term economic stabilisation requirements. That said, a key lesson of the crisis which the IMP did take on board was the need to co-ordinate with the private sector, particularly with regard to private debt rollovers and restructuring, providing key support in particular to the roll-over of Korean short-term debt, negotiations which took place between December 1997 - March 1998.
Many of these points are well made. It most certainly was not the job of the IMP to bail out the Thai, Korean and Indonesian corporate sectors after these had found themselves both over-leveraged and under-hedged. Equally, the IMF cannot be blamed for inadequate regulatory supervision in several Asian countries affected by the crisis, for those countries are lack of sufficient institutional infrastructure for the lack of corporate, market and data transparency. It also cannot be held accountable for the lack of checks and balances which existed in several Asian countries, resulting in significant levels of corruption and vested interests in the case of some. Indeed, the IMF programmes sought to address many of these important issues. Throughout the Asian crisis, IMP policies and programmes attracted substantial criticism from a host of different quarters, some in the U.S. taking the view that it should not provide any bailouts, others in Asia saying that the bailouts were too little too late, yet others who said its key focus on fiscal austerity was misplaced since Asia’s public finances were already in surplus, and finally those who argued that the IMF should have stopped the crisis from happening in the first place. Some of these criticisms were reasonable, some ridiculous, and some betraying the most profound ignorance of the situation. The point about fiscal austerity is notable, and a criticism with some validity given that Asian countries were by no means fiscally lax, that the deficits were at the corporate rather than the public level, yet this was a key aspect of the policy programme aimed at closing Asian external gaps (trade and current account deficits). Granted, this was a brutal way to do it given that it implied that the domestic economy had to pay the price, bad to take the adjustment required to achieve this. But then so be it. The IMF did not create the debts problems. The IMF did not create the current account deficits, indeed in the case of Thailand it issued several warnings on that score. Indeed, the IMF is not a global financial supervisor as some take it. In the event of a financial crisis, it arrives after the fact and whatever its power and influence it cannot order the implementation of its programmes if a programme member is not fearful of getting the loan disbursement ceased.
THE IMF TO THE RESCUE
Returning to stage 1, we find ourselves at the scene of battle, the victors - of whatever nationality or origin - riding off into the sunset with their spoils, the vanquished left to survey a vista of devastation, of bitter defeat. After initially refusing to accept the prospect of having its nation rescued by external elements, the Thai government capitulated on August 20th 1997, financial support for Thailand in the form of a USD17.2 billion aid package that was approved by the IMF. Indonesia followed suit on November 20t and Korea on December 4t of that year. For Thailand, a nation which has never in its history been colonised, succumbing to the pressures of the global market and requiring a national bailout package must have equated to national surrender and subjugation. A package of some USD17.2 billion was put together by the IMF involving multilateral aid from itself, the World Bank and the ADB, plus bilateral aid from Japan, Australia and a number of Asian countries. The specific break up of this is as follows:
Thailand:
commitments
Multilateral USD6.6 billion
IMF 3.9
World Bank 1.5
ADB 1.2
Bilateral USD10.5 billion
Japan 4.0
Australia 1
China 1
Hong Kong 1
Malaysia 1
Indonesia 0.5
Brunei 0.5
Korea 0.5
Total USD17.2 billion
Source: Official Data
Yet, the IMF-arranged bailout package did not come with out strings attached, without a strict programme of terms and conditions which governments had to follow in order to receive further loan disbursements from the package. The IMF stepped into the crisis, armed with its standard programme of belt tightening and austerity measures to cure the ills of any emerging market crisis. In the specific case of Thailand, this is interesting because IMF officials had warned that country’s government on several occasions that the size of their current account deficit was becoming unsustainably large and that it would eventually cause economic dislocation. One must presume that the economists concerned conducting this analysis, whether in Washington or Bangkok extended that analysis to the reasons behind such a significant expansion of the current account deficit and in addition that deficit’s implications. If they had extended that analysis - and surely the presumption is not unreasonable - they would have discovered that the underlying ‘cause et effet” was over-investment in private sector projects relative to what was already stratospheric savings’ rates by Western standards. Armed with this knowledge, they might subsequently have examined the public fiscal account for evidence of imbalance - and found little or none. How to explain this? This surely did not fit the standard model?! Here, one has to say that such an extension of what is pretty basic economic analysis is itself relatively elementary and basic. No great leap of intellect or imagination is required, though admittedly data transparency was an important issue. It is mere logic to assume that someone seeing substantial imbalance and taking the trouble to note that would look for the causes of that imbalance and - bearing in mind the many lessons of the Mexican currency crisis of 1995 - would equally examine for imbalance elsewhere, notably in the fiscal account. Let us assume then that the IMF did exactly that. And as a result, they brought out a report warning the Thai government as to the danger of running such a large current account deficit. They might not have known the size or degree of the Thai corporate short- term foreign currency debt - indeed they probably had no idea of this given that the Thai government seemed similarly unaware - but they must have known that the current account deficit was produced by private rather than public over-investment - remember, that one way of expressing the current account balance is simply savings minus investment. The fact that the public accounts had been in surplus for a decade up until the fourth quarter of 1996 would have confirmed this.
They might, or might not have subsequently examined the available data on private debt, more specifically the data from the Bangkok International Banking Facility (BIBF). If they had done so, they would have tied the two ends together - excessive private investment being fuelled by private, short-term debt, most of it in foreign currency
Of course, I admit fully that much of this is speculative. What is a fact however is that the IMP produced several reports warning Thailand as to the potential economic dangers of its unsustainably high current account deficit. A further fact is that Thailand did absolutely nothing about these reports so a considerable degree of blame for the ensuing crisis must be put firmly at the door of the Thai authorities themselves. This does not however detract from what is a reasonable assumption, that the IMP looked at the reasons behind that growing current account deficit. If one can accept that assumption, then one must come to what is an uncomfortable conclusion. After all, the IMP implemented its standard programme of conditions in Thailand, yet the assumption that the IMP examined specific reasons for Thailand’s current account deficit requires an expectation that they found those reasons, and equally the realisation that these said reasons potentially required different policies and conditions for implementation within the overall bailout programme. Theoretically, the IMF officials responsible for Thailand might have suggested an entirely different and more specific set of policies, based on their greater knowledge of the situation on the ground and the IMP might have completely ignored this and applied their standard programme of remedies despite this being ill suited to the crisis concerned. This is the uncomfortable conclusion that one might come to, armed only with the words and deeds of the official IMF statements. Speculative? Undoubtedly, but by no means a leap of faith. Either the IMF surveillance procedures in place before the Asian crisis did not work, and thus the IMP must itself accept part of the blame (though we know this was not the case given the IMF warning to Thailand), or they did work. But if they did work, why did the crisis happen in the first place? There are two possible reasons: one is that the IMF board ignored their reports, the other is that the countries concerned ignored the warnings. In all likelihood, both were the case.
This had profound implications not only for the initial onset of the crisis, but for its subsequent worsening and for the policies aimed at stopping its progress. Those policies, whatever the findings of IMF staffers or their surveillance procedures, were the same, standard IMF medicine, the same policy responses which the IMF would use in most if not all crises no matter what their characteristics, above all the same IMF mind-set:
• Tighten fiscal policy
• Tighten monetary policy
• Liberalise and deregulate capital markets
• Strengthen supervisory institutions
Most or all of these might seem eminently reasonable to readers, yet the combination of these was not necessarily appropriate in the case of the Asian crisis. For one thing, they were aimed at public spending profligacy, a characteristic of the typical Latin American debt and currency crisis. For another, by combining loan bailouts and tightening the fiscal and monetary policy with the additional requirement of market opening and tighter supervision, they potentially confused the essential aim of the bailout plan itself. Was it to stop the slide, or was it to manage the economy? Here, the criticisms of some Asian countries, namely that more should have been done at an earlier stage, that more money should have been lent and without conditions are potentially valid. If larger loan packages had been arranged at an earlier stage, without market opening conditions and private sector debtors and creditors had been encouraged to negotiate debt rollovers, far less financial and economic chaos might have ensued. If. only. But such criticism is largely self-serving in any case. For one thing, it is not for a beggar to decide the terms of aid. For another, like the CEO of a corporation, a national government is ultimately responsible for the successful running of its country’s policies. Failure is and should be met by summary dismissal.
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