Introduction
The East Asian economic crisis is deep entrenched in the interface of large volume of capital inflows and due to feeble public and private sector administration. At the same juncture, the adjustment of macroeconomic made in these nations has ended in some unexpected results like external adjustment, low inflation and severe economic contractions. The lessons learned from this crisis resolution include the significance of early tight monetary policy and for flexible fiscal policy, exchange rate stabilization and wide-ranging structural reform.
Further, in future, such financial crisis can be avoided by the introduction of diligent bank supervision, prudent macroeconomic policies, transparent dissemination of data, forward-looking policy making, and strong governance that too even in good economic periods. This research paper attempts to review what caused the economic crisis in South East Asian nations in 1997 and 1999 and the role of IMF in addressing the crisis and how IMF was criticised for its effective role and to find conclusions and panacea measures to be introduced to prevent such a crisis in the near future. (Kalpana et al 1998).
Analysis
During the year 1997 and 1999, an extraordinary virulent economic crisis engulfed many East Asian countries. Previously, these economies witnessed sustained growth at unusual rate for nearly three and half decades. Just eight months before the onset of financial crisis and during November 1996, IMF stated in their World Outlook that “East Asia’s strong fundamentals promised good for sustained growth. IMF prediction was based on the region’s vibrant macroeconomic fundamentals like efficient allocation of investment and there was a wide conviction that external atmosphere will prolong to be encouraging.
Between 1997 and 1999, unfortunately, many of the East Asian nations witnessed three times increase in unemployment, a decline of real wages by one-third and decline in the aggregate of income by more than ten percent during these periods. Since the great depression, the East Asian crisis was the most significant and largest economic crisis to strike the world. Most affected due to this financial crisis were the most susceptible like the young, the poor and women. For instance, about twenty-five percent of South Korean population embraced the poverty during this financial crisis. (Knoop 2009: 190). This period is also known as “lost decade” a phrase introduced by Bill Easterly (2001) which means the development and performance of the developing nations in the 80s and 90s.
Thailand was worst affected by the economic crisis in the middle of 1997. Later, the crisis spread over to adjacent nations – Indonesia, Malaysia, South Korea and Philippines and hence, this crisis is widely known to as “South East Asian Economic Crisis”.
Though the experts do not wholly concur on the causes behind the financial crisis, it is construed that the crisis was caused mainly by the following elements.
- Massive quantum of foreign debt and especially, a high ratio of short-run debt.
- Existence of huge current account deficit.
- Arbitrary lending practices by financial institutions and banks, arising from non-adherence of prudent norms by the financial intermediaries concerning capital adequacy, provisioning, asset classification and lack of disclosure norms.
- Huge volume of inflow of foreign investments, especially in the sensitive short–term capital.
- Investors feel handicapped as there is the absence of transparency in the nation’s economic setup which would assist investors to make a prudent judgment and assessment.
- Flooding of investment in many sectors
- Practice of imprudent lending by international lenders.
- Massive appreciation in the real effective exchange rate. (Cherunilam 2004:718).
The East Asian crisis spotlighted a very significant fact that the period before the crisis had not been received much notice from economists in their closed-economy models of business cycles. The veracity is that these East Asian nations are some of the integrated economies on the global level which plays a key part in demonstrating why these nations developed fast during the 1980s and 1990s and also why they collapsed so hard in 1997. (Knoop 2009:191).
The primary goal of this research essay is to demonstrate what we learnt from the East Asian crisis and why IMF failed to predict such colossal economic disaster in advance and the controversial role played by the IMF during the East Asian crisis.
IMF Role
IMF has been criticised for not predicting and stopping the Asian crisis though it is the duty of the IMF to ensure the stability of the international monetary system.IMF is expected through its annual evaluation of every member nation’s economic policies and its performance, by the so-named Article IV consultation and is expected to offer an early caution of turbulent ahead.
However, IMF overlooked the early warning symptoms in Thailand with a clear signal of overheating. In 1997, Thailand witnessed a classic real estate bubble and there was a substantial deterioration in their current account, which accounted for an eight percent gap. Thailand’s exchange rate misalignment was indicated by its weakening export performance. It is to be observed that IMFs warnings issued with escalating force over a phase of twenty four months fell on deaf ears in Bangkok.
It is pity to note that IMF did fail to exhibit enough attention to other warning signals that were ostensible at that period, most evidently the massive accumulation of short-run commitments by both non-bank private sectors and by banks, particularly in Thailand and Korea. Further, data collected by the Bank for International Settlement on the claims by the cross-border bank had a long lag but its coverage was also incomplete. (Hunter et al 1999:5).
Careful analysis of the reasons and outcomes of the East Asian crisis needs paying deep and close attention to the implication and the nature of IMF rescue conditionalities and programmes and policies preferred by the global institution as distinctive from the national financial institutions and communities. IMF as a precondition for the rescuing efforts compelled the East Asian nations to initiate certain financial austerity measures like reduction of governmental spending, closure of nonperforming banks and to announce higher interest rates.
The above mentioned panacea suggested by IMF were resulted in contractionary results, which transformed what had commenced as currency crises and then turned to be a full-blown financial crisis which had rampant ramification on the real economy of these nations. Thus, South East nations like Malaysia, Korea, and Indonesia which had been earlier witnessed massive capital inflows in the guise of portfolio investments or short-run bank loans, experienced recession during the year 1998, after Thailand, which experienced recession in the year 1997. (Carney 2008: 51).
According to Lane et al (1999), In East Asian Economic Crisis, IMF misjudged the callousness of the economic collapse of these nations and also miscalculated the strength and the speed of recovery.
Stiglitz contends that the significant contributing element to the East Asian Economic Crisis was the liberalisation of capital account and the liberalisation of flow of capital, especially currency. East Asian nations were encouraged by the Western world to liberalise their economy by permitting foreign investors to have an easy entrée to their Asian markets. For instance, after the Plaza accord during the year 1985, Japanese Yen appreciated against the US dollar which made Japanese export dearer. Due to this, Japanese firms lost their competitive advantage in the international market. This forced the Japanese manufacturers to shift their operation to the cheap manufacturing sites. Thailand attracted huge volume of Japanese FDI due to its cheap labour. (Cherunilam 2004:718).
Due to this liberalisation, huge volume of foreign investment flowed in to these economies. However, the East Asian Nations failed to have the adequate regulations restricting withdrawal of foreign investment prematurely without any penalty.
This also implies that the IMF not only did not comprehend the real reasons for the economic crisis but was also incompetent to design a required panacea or policies in retort to it. Some critics at the outset were of the opinion that whether the IMF was understood the novel factors of the crisis and their significance. The apparent failure by the IMF to predict the crisis in its normal periodical reports on these regions just before onset of the crisis and its part in worsening the recession in Korea, Thailand and Indonesia and this surely does not instigate much confidence. Further, despite the fact that even though the Philippines had long been associated in the IMF schemes and subject to its control, but it was not spared from the economic meltdown.
Normally, in any financial crisis, there will be intervention by IMF and there will be an offer of a bailout package. These bailouts are famously called as ‘structural adjustment loans’ which are usually offered with conditions attached. These conditions demand that the crisis affected nation agree to devalue and then to defend its new exchange rate and also to introduce the reforms to their macroeconomic policies that made the nation engulfed into the crisis. In the majority of cases, these reforms consist of austerity measures. (Knoop 2009: 192).
According to Stiglitz (100), “capital inflows are pro-cyclic and during the recession, if capital flows out of a nation, it would kindle inflationary pressures in the economy.
IMF was accused of prolonging the Asian Economic crisis as it declined to lend finance to East Asian countries, unless they introduce some economic reforms as described under;
- To decrease the spending by government. For instance, Indonesian government had to dismantle fuel and food subsidies during April 1998.
- To increase their interest rates and in most cases, increase amounted to as high as twenty five percent.
- Many East Asian nations have been compelled to wind up non-performing domestic banks.
- Many nations experienced mass layoffs, which resulted in severe unemployment crisis.
- For instance, South Korea enacted financial reforms and had been compelled to permit international companies to partake in its domestic markets.
IMF also overlooked the weakness in corporate and bank balance sheets in Asian region during 1990s. IMF was not aware of the unusual leverage of Korean companies as in certain cases it had a ratio of 600/1 debt to equity. Further, IMF not pay much attention on the weak disclosure and accounting practices of non-banks and banks or the liberal loan loss provisions and liberal rollovers of clients of banks to their major customers.
IMF also underrated the Japanese government’s condensed fiscal stance on its weak economic recovery. Further, IMF also underrated the impact of political factors and political risk that existed in the South East Asian economies. IMF did not aware the frantic initiatives by central banks or by some governments to protect their exchange rates in 1997, and it was unaware the fact that both Korea and Thailand had depleted their forex reserves by the time when it turned to IMF for assistance.
Further, IMF, being an international monitoring agency did not aware that central bank of Thailand released more than $10 billion thereby intervening in the forward, spot and swap markets and further it did not aware that on May 14 1997, Thailand’s forex reserve came down from $24.3 billion to just $2.5 billion. (Hunter et al 1999:6).
IMFs defence against the criticism that its conditions to the Asian crisis nations were misapprehended and reiterated that in a short-run crisis, the resources at the disposal of affected nations were fixed, and they could not substitute for the private flow. (Michie & Smith 1999:363).
The above supervisory failures on the part of IMF towards happenings in South East Asian economies had corroborated the allegation that IMF and its adjustment policies were responsible for sharp currency depreciation in these economies.
One another salient factor was the degree of hedging of local currency risk by foreign investors and lenders with unhedged Korean, Thai and Indonesian companies and banks and in certain cases, the respective governments itself as other parties. This hectic hedging activity was not restricted to the specialised “hedge funds” but was a nucleus feature of the 1990s portfolio and credit investment boom in upcoming markets. However, the majority of these hedges offered no protection at all. IMF report did not cover these areas as there are restricted disclosure needs for off-balance sheet transactions. It is just to comment that the derivative is the real black sheep for the Asian financial crisis. (Hunter et al 1999: 6).
As per Dr.Sachs, the rigorous macroeconomic regime was theoretically sound, but it failed to bring anticipated results. IMF role was criticised as mechanical, and it had blundered and made the crisis still worse.
As per Joseph Stiglitz, World Bank’s Chief Economists, IMF should have concentrated more on the things that were responsible for crisis and not on actions that caused it more difficult to deal with. (Zhang 1998: 92).
Though IMF was criticised that it failed to prevent the currency decline during Asian crisis, it could not have held that it was culpable for it. IMF acceded to the Thailand’s request for relaxing some conditions due to severe economic conditions. Further, the sharp decline of Bath was due to erratic nature of investor’s confidence but not due to IMFs insistence for credit contraction and austerity measures. It is to be noted that though Malaysia which has not received any assistance from IMF and is not under IMFs strict programs, also saw its currency taking a beating. (Zhang 1998: 92).
Bird, G (1996) was of the view that developing nations should rely more deeply on customary economic policies despite the fact that IMF-backed programmes that have assured them earlier have generally failed except in action like fortifying the balance of payments.
Lessons Learned
What we have learned from the Asian crisis is that tight monetary policy is to be introduced at the early stage and interest rate can be minimised once the exchange return to stability. Further, fiscal policy should be flexible enough, which should reinforce the social safety net and fund the cost of restructuring of financial sector’s restructuring subject to financing restrictions. Further, both corporate and bank reforms should be introduced to restore viability at the same juncture efforts should be made to offer incentives for maximisation of profits.
The Asian crisis also taught a valuable lesson how a crisis can be prevented. For crisis prevention, both an outward orientation and prudent macroeconomic policies are needed. Further, there should be the proper supervision mechanism for banks and there should be transparency on data dissemination. Strong and vibrant administration is required to make sure of the free play of market forces. For the introduction of capital account liberalisation, there should be well management of external debt and there should be healthy domestic financial sector. Pragmatic policy making that understands and addresses issues early should help to prevent a crisis.
To prevent Asian crisis in future, financial reforms should be introduced, which will strengthen the efficiency of the intermediation. Actions should be initiated to fortify the working of financial markets including by dismantling the associations between banks, business and government, by improving transparency with regard to reporting of key financial, economic and corporate sector data and information and fortifying of the social safety net.
Thus, there is a necessary to introduce tight monetary policy, which will minimise the initial speculative pressures and will result in stability of exchange rates and to control inflationary pressures. (Kalpana et al 1998).
Conclusion
IMFs activities in Asia since mid-1997 did not have more panacea effects except fulfilling its charter. Preventing the crisis would have been appreciated and IMF as a responsible international agency should endeavour to find the means to minimise the likelihood of such occurrences in the near future. However, when a financial crisis has occurred, IMF is the sole institutional mechanism to address the same. Just spotlighting on the crisis alone, however, gives a very partial panorama of the IMFs part in Asia. Indonesia, Thailand and Korea have been the member of the IMF for long time. During these periods, IMF might have associated more closely with the authorities in these nations through technical assistance, surveillances, training of officials and reform programs.
The lesson learned from the Asian crisis is that only application of all inclusive reform strategy with determination will overcome these hurdles. The IMF –backed reform programs in Asia are not just austerity programs, but they respond to the reversal of capital flows and they build on macroeconomic stabilization by supporting more effective resource distribution through setting new roles for governments. (MeLeod & Garmaut 1998:264).
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