IMF's about-turn on fiscal stimulus won't work

By Salil Tripathi in Singapore, Far Eastern Economic Review, 29 October 1998

It is a policy reversal that the International Monetary Fund has begun to push aggressively. Throwing off its customary austerity, the IMF wants Thailand, South Korea and Indonesia to rev up their fiscal engines and spend their way out of the economic blues. And if they rack up budget deficits in the process, that's okay, too.

The IMF set budget deficits in September at 3% of GDP for Thailand, 4%for South Korea and 8.5% for Indonesia, revised since the Fundannounced its policy about-turn in July. But economists say the size ofthese deficits won't be sufficient for badly needed bank capitalization andsocial safety-nets. What's more, governments are loath to fall too far intothe red, anyway.

As many experts see it, this impetus isn't strong enough. At such a time Asia needs a massive fiscal stimulus, and that's not coming through,notes Manu Bhaskaran, chief strategist at SG Securities in Singapore. P.K.Basu, chief economist at Credit Suisse First Boston in Singapore, concurs.Using Thailand as an example, he notes that the country's budget deficit ofabout 200 billion baht ($5 billion) forecast for 1998 is too little, given thatits current-account surplus is expected to be 418 billion baht. He points out that Thailand's GDP is targeted to shrink 8.3%. Because deficit financing is measured as a percentage of GDP, in absolute terms, Thailand's publics pending would be less in 1998 than it was in 1997. If that isn't tight money policy, what is? muses Basu.

Indeed, some economists believe the fiscal stimulus won't work unless governments use their rising foreign-exchange reserves to increasedomestic spending. Exporters sell the hard-currency earnings they bring into the country to the central bank via commercial banks. To pay for the hard currency, the central bank either prints new money on the strength of the increase in its reserves, or reduces the capital-adequacy ratios of the commercial bank concerned. This creates new liquidity in the system-a monetary expansion that the IMF would readily approve. The main worry is that the commercial banks might use the new liquidity to boost their reserves rather than lend it out, thus weakening the fiscal-stimulus initiative. There is an air of irrational exuberance in the IMF's thinking,says a regional economist with a European brokerage in Singapore.

The severity of Asia's economic illness prompted the IMF's monetary rethink. Circumstances have changed since the IMF first urged tight monetary policies on Asia's sick. The early days required austerity to help economies to stabilize. That period is behind us. Now is the time toexpand, says IMF Asia-Pacific Director Hubert Neiss, reiterating an argument that the IMF has been making for the past three months. Indeed, the region is beginning to perk up: Currencies are no longer bouncing like yo-yos; interest rates-although still high-have fallen; and foreign reserves have grown since the lows of 1997.

Neiss believes a fiscal stimulus-handled properly-will help liquidity toflow back into Asia. He says confidence in the region would return byearly 1999, thus attracting private money, if global conditions arefavourable. This in turn will help governments to pay for bankrecapitalization, easing the burden of corporate debt.

But the IMF's target economies aren't completely convinced. In other countries, we have to urge governments not to run budget deficits; in Asia, we have to encourage them to expand fiscally. But Asians don't like running large deficits, said Stanley Fischer, the IMF's Washington-based deputy managing director.

Indeed, Indonesia and South Korea have dragged their feet in stimulating demand because they are accustomed to running budget surpluses; in the past, multilateral agencies, including the IMF, have praised them for this. And Thailand has resisted a larger budget deficit, says an IMF official in Bangkok, despite a blank cheque that the fund is willing to write forsocial spending. In fact, Asian governments had wanted to steer clear of budget deficits altogether, hoping that export earnings would bounce back and foreign capital would return. Neither has happened, admits Miranda Goeltom, adirector at Bank Indonesia, the country's central bank. Exports haven't risen in dollar terms in Thailand, South Korea and Indonesia, for example, as global overcapacity has depressed prices in the key Asianmanufacturing industries such as electronic goods. Nor is it likely that the volume of exports will pick up; the pace of world economic growth is forecast to slow to 2% in 1998 from 4.1% in 1997. Foreign capital, too,remains skittish. David Hale, chief global economist at the Zurich group inChicago, doesn't think it will return anytime soon to Asia-or to any emerging market, for that matter.

But the IMF's fiscal-stimulus plan perhaps offers too little, too late. If governments will spend less in absolute terms in 1998 than they did in previous years, the outlay for bank recapitalization or social safety-nets simply won't be enough. According to estimates by the Asian Development Bank early this year, social-safety schemes would cost 7% of GDP in Indonesia, and about 5% of GDP in Thailand.

Calculating the cost of bank recapitalization is trickier, but Asian bankers say it could range from 25% to 50% of GDP in each of the three countries. Depending upon exchange rates used, that could amount to between $75 billion and $150 billion. But current-account surpluses for the trio are expected to collectively total just $57 billion, says SG Securities in Singapore.

There are few financing options available, however. The World Bank andthe ADB can provide only a fraction of the needed funds. Tapping Asia'sprivate savings would be difficult. Few Asian countries have activemarkets for bonds, or other fiscal instruments, in which to pour savings.Depending upon the limited fiscal stimulus would be like depending upon afreak shower to reinvigorate a parched landscape.