The IMF cometh to the region

The IMF cometh to the region

Manuel F. Montes looks at some of the implications of the IMF rescue packages for three Asian countries.

SINGAPORE: The International Monetary Fund (IMF), long the bane of import-dependent economies with profligate governments in Latin America and Africa, has come to Asia to help rescue Thailand, Indonesia and South Korea, whose record had helped to secure Asia's reputation of export vigor and conservative economic management. Under the approach typical of IMF programs, these economies face at least a year of slow growth, company failures, rising unemployment especially in the urban areas, cuts in government programs, high interest rates, investment malaise, and domestic political recriminations over the impact of the programs and the loss of policy flexibility, after the steep currency devaluations they have already undertaken. Will the medicine work in Asia, where the nature of the underlying problem is different?

In exchange for these troubles, the economies hope to get some breathing space from the currency attacks that have afflicted Asian economies since the Thai authorities attempted a gradual devaluation of the baht which was quickly overtaken by the panicky reactions of Thailand's creditors, resulting in Thailand seeking IMF protection in mid-August 1997. Thailand obtained US$4 billion from the IMF, within a total rescue package of US$16 billion. Indonesia sought IMF protection on Oct. 8, 1997, after the international value of the rupiah had fallen almost 40 percent. The total Indonesian rescue package was US$23 billion, of which the IMF contributed US$10 billion. On Dec. 5, 1997, Korea obtained a US$57 billion program of which the IMF contributed US$21 billion.

These rescue packages are unprecedented in their size. In 1995, the total Mexican rescue package at US$48 billion was itself unprecedented. In Asia, in less than half a year, these three rescue packages now total almost US$100 billion. In all these cases, the size of the packages is meant to reassure external creditors that their leftover exposure to the countries involved will be protected and that there is no need to cut their credit lines not only to the countries directly involved, but to other countries they might deem to be in a similar situation. It is still not clear if the Korean package is large enough to reassure foreign creditors, as the currency attacks on the won continued.

The Asian IMF programs are also unprecedented in the sense that the programs have more to do with reforming the countries' financial systems than with restoring a sustainable balance in the economies' external transactions. The IMF's comparative advantage is with the latter and its principal approach in restoring external balance has been in "domestic demand management" which requires cuts in spending by the governments involved. Domestic spending cuts reduce the country's demand for imports and also cause a slowdown in economic activity. In the case of Korea, the planned IMF program forecasts a halving of the rate of economic growth in 1998.

For the Asian countries affected, a case could be made that further cuts in government spending are uncalled for. Savings rates have been high and government deficits have been low or non-existent in these countries, and in most of Asia. The resulting slowdown in the Asian economies, including those carried out by governments not under an IMF program such as Malaysia, will reduce exports into the region from Japan, the U.S., and Europe and is the proximate cause of the reduction in the IMF's own forecasted world growth rate for 1998 from 4.3 percent to 3.5 percent.

The reform programs for Korea, Indonesia and Thailand include reforms to improve the transparency of the banking system and stock markets and of the oversight capacity of public authorities. These reforms actually take more time to realize, but any efforts in this area improve the regulatory reputation of domestic authorities in the eyes of the world and should be stabilizing. An important feature of the Korean program is the implementation of accounting standards that would force Korean companies to provide a clearer view of their financial condition. The proposed program reduces the power of Korean conglomerates (chaebols) to borrow at favorable terms from their own related banks.

Particularly in the case of Korea, the IMF programs also involve further opening of the economy in trade and for external investment. As part of its accession to membership to the Organization for Economic Cooperation and Development (OECD), the group of advanced industrial economies, Korea had previously announced phased measures to liberalize investments into Korea. The IMF program represents an acceleration of these plans. This means that the features of these measures to open up the economy have been previously studied and discussed in Korea, only their implementation will be brought forward.

As long as short-term international investors are assured about an economy's ability to service their external debt and the currency meltdowns cease, the IMF medicine can be said to have worked for the countries affected, but at a considerable cost. The strategy of high domestic interest rates combined with economic growth slowdowns will further weaken financial institutions, reduce corporate earnings, and turn some sound investment projects into problematic ones. Given the normal practice of syndication and joint guarantee among banks, the strategy of rapid writedowns and sell-offs in property and financial assets will depress these prices equally rapidly and endanger the health of banks whose portfolios were basically sound before the crisis.

After its US$35 billion commitment to the three Asian economies, the IMF would only have US$44 billion left to deal with any further requests; in 1996, the IMF only committed US$8 billion. Not only does the IMF find its own resources severely limited to face future requests, the pattern of contagion suggests that the IMF cannot in the future deal with individual country problems and must begin to consider the nature of global financial markets in its operations. Because of the integration of global currency markets, the days when the IMF could fly into town and advise the devaluation of one country's currency without effectively causing the devaluation of currencies of related countries are probably long past. That an international crisis could strike so deeply in a region of the world generally considered to be economically healthy also shows the weaknesses of international institutions, including the IMF, in dealing with such crises in the new economic environment.

The Asian experience suggests two things. First, domestic authorities' responsibilities in maintaining the soundness of domestic financial systems becomes even more critical in a world of integrated capital markets. Secondly, the search for ways to improve the stability of currency parities and to improve institutions, including the IMF, to deal with such types of multi-country crises must become a key item on the international agenda.

Dr. Manuel F Montes is a Senior Fellow at the Institute of Southeast Asian Studies, Singapore.