Date: Fri, 23 Jan 1998 07:22:21 -0500
Sender: Southeast Asia Discussion List <SEASIA-L@msu.edu>
From: E Phillip Lim <ALSONA@PACIFIC.NET.SG>
Subject: Resolving the Asian currency crisis

Resolving the Asian currency crisis: IMF is not geared adequately to help

By Dr. Augustine H.H. Tan,
in Straits Times Forum
23 January 1998, p. 58

I refer to the letter "Attacking IMF and encouraging resistance can worsen situation" by Professor Linda Lim (ST, Jan 14), the interview with Professor Jeffrey Sachs, "I'm in no government's pay" (The Sunday Times, Jan 11) and the article "IMF: The hand that knocked off the cradle" (Business Times, Jan 16).

Prof Sachs may have overstated his case but Prof Lim's analysis is not helpful either.

I do not agree that fair comment on the International Monetary Fund is tantamount to "attacking IMF and encouraging resistance".

There is surely a legitimate question about the effectiveness of the IMF's rescue operations, if only because regional currencies have continued their downward slide with disastrous consequences.

It is true that there are strong sentiments in the United States against further funding of the IMF, but Prof Lim will surely agree that free and open debate is the best way to ensure that the right things are done.

Besides, the IMF also has its own track record and is able to defend itself.

Allow me, however, to state my own position clearly.

I am not in favour of bashing the IMF, but I believe that the resolution of the Asian currency crisis requires resources and intervention beyond the scope of the IMF.

The latter is not geared adequately for this kind of crisis.

THE FACTS

[] Right up to July last year, nobody anticipated the crisis or its extent.

[] The malaise affects several Asian countries

[] The root of the problem is unlike the typical Latin American or African fiscal and monetary excesses, with the exception of Chile in 1982 and 1985.

Its indebtedness was almost totally caused by private sector overspending.

[] The proximate cause of the crisis is foreign over-borrowing by banks, corporations and individuals on a short-term basis.

According to Neil Behrmann's article, "Euro banks admit to Asian lending spree (Business Times, Jan 20) this amounts to US$ 241 billion (S$ 421 billion) or 62 per cent of the Bank of International Settlements' lending to Asia.

[] There were a number of structural defects or "fault lines" that contributed to the crisis' severity. There are:

1. The use of political rather than commercial criteria in the allocation of loans, as in Thailand and Indonesia.
2. Industrial policy used to finance massive expansion of industrial capacity, resulting in gluts, such as in South Korea.
3. Poor supervision of financial institutions.
4. Costly and unjustifiable bail-outs of financial institutions, such as in Thailand.
5. A penchant for mega-projects -- albiet financed and executed by the private sector --- at above-market prices.
Needless to say, these came with mega-commissions, without regard for balance of payments implications.

THE ASIAN MIRACLE

How did the crisis happen? To understand this we need to comprehend the Asian miracle.

One part of the miracle has to do with good macroeconomic policies, high savings and investment rates, plus a well-educated, trained and hard-working labour force.

The other part has to do with the Plaza Accord of September 1985, which devalued the US dollar by some 50 per cent against the yen.

Because of the exchange rate pegging system used by Asian countries, whereby, directly the US dollar is dominant, Asian currencies are effectively devalued, just as in the early 1980s they were over-valued along with the dollar.

This triggered substantial capital inflows into the Asian economies in four over-lapping waves:

[] To cope with a strong yen, Japan relocated many industries to East and South-east Asian countries. This Japanese lead was followed by European and American investors.

[] In the Asian countries, with the infusion of direct investment in manufacturing, rents rose and property appreciated, triggering another wave of capital inflow, both to develop property and to purchase it.

[] Asian stock markets in turn boomed, attracting foreign management funds, which fueled the boom further.

[] High economic growth rates in turn strained infrastructure, attracting another wave of foreign investments.

All these waves of foreign investment involved substantial foreign borrowing on a short-term basis, as currency risks were minimised by the pegging of exchange rates.

THE ECONOMIC UNRAVELING

How did the boom unravel? There are three dimensions.

[] The global scene: Firstly, over the last decade, the US has been trimming her Budget deficit which, in turn, enabled monetary policies to be tighter. At the same time, the American economy has become more competitive through retooling, and more. Secondly, in recent years, the members of the European Union have been tightening fiscal and monetary policies, in order to fulfill the Maastricht criteria, as a pre-condition for membership of the common currency, the Euro. Thirdly, the early 1990s saw the emergence on the global market of several new actors: the former members of the Soviet Union, Latin America, some African countries and India.

THE REGIONAL SCENE

[] In early 1994, the Chinese yuan was devalued 35 per cent.
[] From 1995, the Japanese yen depreciated 30 per cent.
[] From 1990, the Japanese economy was in depression, following its central bank's unwise and sever deflation of the property market.
[] From 1996 until late last year, the electronic industry was in a downturn.

The impact of these regional factors on the Asian economies was severe. Low-tech and high-tech exports were hit badly.

THE NATIONAL SCENE

[] The property glut: As in the early 1980s, when the US dollar was strong, the over-valuation of regional currencies meant asset inflation (there was a resource shift from the traded goods sector to the non-traded sector). Overbuilding resulted and the consequent downturn affected share prices as well as the health of financial institutions, which were over-extended in property market loans.
[] In recent years, the new World Bank-Asian Development Bank orthodoxy or privatisation, and hence reliance on the private sector for development of infrastructure projects, led to extensive foreign private borrowing for such purposes. These projects generated heavy imports requiring payment in foreign exchange, while the revenue received was in domestic currency. Subsequent repayments of interest and amortisation contributed further to the current account deficit.
[] The pegged exchange rates removed exchange risks and encouraged extensive borrowing by banks, corporations and individuals wanting to take advantage of cheaper foreign loans.

Indonesia, for example, could borrow US dollars at 6 to 7 per cent interest and earn 20 per cent on rupiah deposits, netting a profit of 89 per cent after the normal 5.6 per cent annual depreciation of the rupiah.

The unraveling began with Thailand in July last year and spread rapidly.

THE ROAD BACK

Prof Jeffrey Sachs has aptly used the analogy of a run on the bank to explain the crisis. Asian countries were essentially borrowing short to invest in long-term assets.

Add the corruption, cronyism and mismanagement, and the Paul Krugman hypothesis of over-investment comes into the picture.

Unfortunately, unlike a domestic run on a bank, where the central bank can step in with lender-of-the-last- resort facilities, there is not international lender of the last resort.

The IMF's functions are limited to supervising the orderly conduct of international trade and finance, and providing temporary financial to alleviate balance of payments difficulties.

The IMF's remedies of fiscal and monetary contradiction are more suited to problems arising from government over-spending and printing of money, and when foreign debt is largely sovereign.

The Asian crisis is radically different. Given the short-term and private nature of the affected countries' foreign debt, the sudden withdrawal of funds by foreign lenders brought about a liquidity crisis in the first instance, not a crisis of insolvency.

Failure to provide lender-of-last-resort facilities converted liquidity into insolvency.

An Indonesian who borrowed US$ 1 million at 2,400 rupiah now faxes a repayment of more than 10,000 rupiah.

The result has been wholesale bankruptcies. In turn, financial institutions go under.

IMF-mandated fiscal and monetary deflation has produced more casualties. Is it any wonder that the end of the crisis is nowhere in sight?

What is really needed?

As has been done for S. Korea and others in the past, the US, Japan, the European Union and the IMF should help to encourage lenders to reschedule loans.

Japan must urgently and significantly reflate her economy via fiscal and monetary expansion.

The US Federal Reserve Bank should work with Japan and the EU to bring down the value of the dollar significantly.

Finally, the IMF needs substantially more resources.

If these measures are not implemented urgently, the contagion is likely to spread.

Recall the Great Depression with competitive devaluations, protectionism and large-scale unemployment. A similar scenario could unfold today. Let us hope and pray that more wisdom prevails now.

Dr. Augustine H.H. Tan

The writer, a former MP, is Associate Professor at the Economics Department, National University of Singapore