High interest rates prove IMF failure

High interest rates prove IMF failure

HONG KONG (Dow Jones): The grip of high interest rates in Southeast Asia is showing the failure of the International Monetary Fund programs and will lead several nations to permit higher inflation, according to a Morgan Stanley & Co. analyst who has sharply reduced his 1998 expectations for regional currency exchange rates.

"The crisis economies need lower real interest rates. The lack of a framework for monetary policy (adjustment under the IMF programs) means there is no credible means of reducing nominal interest rates without exchange rates in these countries gapping down. For this reason, we consider it more likely that real rates will be reduced by means of an acceleration of inflation.

Monetization of a larger fiscal deficit will deliver the higher inflation, in our view," said the report from Tim Condon, an economist for Morgan Stanley in Hong Kong.

The report, published Wednesday, offers a view that Southeast Asian currency exchange rates will sharply fall through year end.

It forecasts the dollar at 15,000 rupiah, 5 Malaysian ringgit, 47 Philippine pesos (PHP), 50 Thai baht and S$2 -- all downward revisions in the firm's forecasts and lower than current levels.

The dollar is also seen rising to 1,700 won by the end of this year, although the prediction isn't a change from previous Morgan Stanley estimates.

The firm's analysis emphasizes the lack of money supply growth around the region as shown by rises in the M1 and M2 multipliers.

Everyone is holding deposits, with consumers apparently fearing deflation and investors sidelined, the report said.

Deflation has been seen in two of the past three months in South Korea, while inflation has dropped to about zero in Thailand, according to the report.

"A sharp drop in the velocity of money is terribly destabilizing to economic activity," the report said. "The IMF programs have caused the drop in velocity.

"The IMF programs are failing, in our view, because they underestimate the time it will take for foregin capital to flow back into the crisis economies," according to the report.

Crushed

"Meanwhile, the stabilization of currencies in the IMF- supervised countries has crushed economic activity."

Indonesia "has shown the way" by letting its inflation rates rise, even as credit remains tight. It will probably become a high-inflation economy, although not a hyper-inflationary environment, according to Morgan Stanley.

"Higher inflation -- not hyperinflation -- need not be catastrophic. High inflation has been part of the re- capitalization process following financial crises in many emerging markets. Asia has long been an inflation-resistant region, and we do not forecast any country moving into destabilizing high inflation," Condon's report said.

The firm now sees next year's annual inflation rates at 25 percent for Indonesia, 9 percent for Malaysia, 7 percent for the Philippines, 10 percent for Thailand and 2 percent for Singapore.

South Korea will record 10 percent inflation in 1999, the firm's report said.

The higher inflation rates will put downward pressure on nominal exchange rates and make it more difficult for corporate borrowers to repay their external debt, increasing the need for private external debt restructuring.