IMF pressed to review its Asian strategy

IMF pressed to review its Asian strategy

HONG KONG (Dow Jones): Asia's economies are choking on the harsh medicine ordered by the International Monetary Fund. As a result, more and more economists are saying it's time to rewrite the IMF prescriptions of high rates and anemic government spending, which is spawning a new debate on how to rescue Asia.

The high rates were intended to stabilize battered currencies and economies. But with currencies tumbling yet again, the stabilizing effect of high rates appears to be wearing thin.

Unlike earlier IMF critics, who argued the IMF had bungled Asia's rescue, these economists say it was right to raise interest rates in the early days of the crisis. Tight monetary policy aims to cut off profligate spending and attract capital with the promise of higher returns -- thus helping to stabilize economies.

But the benefits of those high rates now are looking illusory. That's mainly because the effects of Japan's recession are filtering into the region, causing expectations across Asia to tumble.

"The market mechanisms you need for high interest rates to work have broken down," said Bill Belchere, economist at Merrill Lynch in Singapore. "There's an unwillingness, even if the channels are open, from investors to put money in because they're not confident that the IMF restructuring is going to work."

Meanwhile, deflation and collapsing domestic demand are strangling the region's economies, and easier credit could help to end the downward spiral, the economists said.

"You want to have currency stability," said Tim Condon, regional economist at Morgan Stanley Dean Witter in Hong Kong. But the costs of the current "strong currency, weak economy" policies outweigh the benefits. "They're just destroying their economies. The middle class is being wiped out," Condon said.

Not just the middle class. The World Bank's vice president for East Asia and the Pacific, Jean-Michel Severino, painted a bleak picture of job losses and growing poverty, and he warned this could trigger political trouble. "Let us remember that the hungry can become angry," he told a conference Tuesday in Australia.

The IMF is sticking to its guns. David Nellor, the IMF's assistant director for Asian and Pacific Affairs, warned at the same conference that higher government spending could ignite inflation. "I think maybe we are talking about a matter of degrees," he said. "I think it's a matter of finding a way to balance the objectives" of government support for the economy and suppressing inflation.

Hubert Neiss, the IMF's director for Asian and Pacific affairs, said Monday in Jakarta that "the rupiah would have fallen further if the interest rates were lower than the current level."

The IMF's recovery recipe for Asia has been repeatedly attacked by academics and politicians. However, private-sector economists have generally toed the IMF line, at least publicly. So have most of the countries the IMF has aided.

Indonesia

Even Indonesia is coming around -- the government will maintain high interest rates even though they haven't provided support to the nation's beleaguered currency, according to central bank Governor Sjahril Sabirin.

Lowering rates, he said, would only serve to weaken the rupiah against the U.S. dollar. The Indonesian currency weakened in Asian trading yesterday, falling to more than 16,700 rupiah to the dollar.

The IMF's recovery recipe goes something like this. High interest rates attract capital flows and prevent outflows, relieving the immediate pressure on exchange rates. High interest rates and tight credit also chill domestic demand, thereby reducing imports and prompting a shift of resources to export industries. Eventually, the currency steadies and the balance of payments comes back into balance, allowing interest rates to come down.

Trade balances are swinging into surplus, due almost entirely to stunning declines in imports, rather than export growth. The overall balance-of-payments situation still looks fairly grim, however, because capital isn't flowing to Asia's crisis-struck economies.

The economic contractions are so severe that currencies and stock markets across Asia were sliding even before the yen swooned last week.

Nobody is arguing against the virtues of stable currencies. Instead, advocates of easier credit are simply arguing that exchange rates shouldn't be the main issue right now. The focus, they say, should be on credit, which is the fuel that drives the economic engine -- and Asia's economies are running on empty.

"Yes, there is absolutely a need to ease domestic monetary conditions," said Chris Tinker, chief economist at ING Baring Securities in Hong Kong. However, he said that won't be enough to revive credit flows. Stuffed with bad loans, many Asian banks are unable or unwilling to lend. "The ability of the authorities to change that is limited," Tinker said.

Indeed, the main measure of progress shouldn't be interest- rate levels -- it should be access to credit, argued Linda Tsao Yang, the U.S. representative to the Asian Development Bank in Manila.

"You need to damp this investment boom and indiscriminate borrowing, and high interest rates do serve that purpose," she said. "But if the small and medium enterprises -- especially the export-oriented ones that drive the economy -- don't have access to credit, then it's a big problem." That can happen even in Japan, she noted, where interest rates are less than 1%.

High rates also exacerbate Asia's mountains of domestic debt, which in Thailand, South Korea and Malaysia far exceed foreign liabilities. A new study by Deutsche Bank argues that domestic savings have played a far bigger role in generating economic growth in Asia than international capital flows. But if interest rates don't come down, these savings could be wiped out along with the banking systems they are kept in.

High rates were the right idea at first, said Deutsche Bank economist Angus Armstrong. "Interest rates should have been allowed to come down," he said, adding: "We think they're not attacking the big problem, which is the debt."