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CIAO DATE: 12/99
The Asian Crisis: The Return of Growth
June 17, 1999, Hong Kong
Introduction
Four months ago in Manila I had the pleasure of addressing the Asia Society’s Tenth Annual Corporate Conference. My talk on that occasion was entitled “The Asian Crisis: The Beginning of the End?” Tonight we can safely remove the question mark, and talk about the return of growth in Asia—in the Asian crisis countries of Indonesia, Korea, Malaysia and Thailand; in the Philippines, which avoided the worst of the crisis; and significantly, in Japan.
Like a seismograph, the EMBI (Emerging Market Bond Index) spread provides a good index of the intensity of a crisis. The devaluation of the baht in July 1997 shows up as only a minor tremor. The real start of the crisis is marked on the EMBI index by the attack on Hong Kong in October 1997. The eighteen months since then have been exceptionally difficult for Hong Kong. Nonetheless, the Hong Kong economy has successfully withstood massive external shocks, and the linked exchange rate remains strong. And as the other Asian economies hit by the crisis recover, Hong Kong too, with its policies continuing on the right track, has very good prospects of recovery in the second half of this year.
The Recovery
The regional outlook has improved markedly in the last few months. The countries at the heart of the crisis, Korea, Thailand, Malaysia and Indonesia are probably past the turning point. Even in Indonesia, where macroeconomic stabilization took the longest, economic activity is expected to pick up in the second half of the year. The recent economic stability in Indonesia, supported by generally good macroeconomic policies and foreign official financing, was essential in helping to ensure a peaceful background for the elections.
These recoveries are built on expansionary domestic policies, fiscal and monetary, and on the beginnings of the recovery of exports. They have been helped by the return of foreign capital, both financial, which has strengthened stock markets, and foreign direct investment. In Indonesia, Malaysia, and Thailand, the recoveries remain fragile, and depend on the continuation of structural reform policies, as well as on an improving the external environment. In Korea too, the structural reform agenda is far from complete, particularly in restructuring the chaebols.
Among the potential victims of the crisis, the Philippine economy performed exceptionally. The Philippines was in an IMF program at the start of the crisis, and it skillfully pursued good policies, both by allowing the exchange rate to adjust when it came under pressure, and by defending it through interest rate policy. As the economy came under pressure, IMF financing for the Philippines was increased. The country benefited from the composition of its trade, which is more heavily weighted towards the United States than that of the more severely affected countries.
Japan accounts for more than half of the output of the region. There could have been no better news for the region than the strong first quarter recovery reported for Japan. While it is yet to be seen whether the recovery is firmly under way, policies are now playing a constructive role to strengthen demand, and bank recapitalization is underway. It will likely be necessary later in the year to ensure that fiscal policy continues to support the expansion.
And China has continued to weather the crisis better than many expected: a well-timed fiscal stimulus has helped to support activity, and the stability of the yuan has been maintained. A daunting agenda of structural reform of the state sector and the banks remains, but the authorities have made it clear that they are committed to accelerating reforms in these areas.
The Risks
However, all this is fragile. The continuation of the recovery depends on domestic policies, which in turn depend on domestic politics, as well as on the external environment.
One important risk is that the burgeoning recovery will reduce the urgency of reform and allow complacency, or normal politics, to set in. Much structural reform remains to be carried out in the crisis-struck countries: Indonesia, Korea, Malaysia, and Thailand, and also in China and Japan. As stability and growth return, and as the role of the international financial institutions inevitably diminishes, those countries that have had International Financial Institution (IFI)-supported programs are going to have to internalize the ongoing reform process. We will continue to do everything we can to support the continuation of the reform process through the IMF-supported programs as long as they continue, and then through the surveillance process.
The external environment is also critical. The phenomenal strength of the United States economy during the last three years has been the bulwark of the world economy; essential in preventing the Asian and then the Russian crises from generating a worldwide recession. United States monetary policy in October and November 1998, followed a bit later by the co-ordinated cut in European interest rates, was decisive in containing the contagion from the Russian crisis. But the United States economy cannot continue to grow at rates well above any estimate of potential growth, especially when unemployment is so low. We must hope that European and Japanese growth will pick up in time to offset the inevitable slowdown in the United States—noting that while a slowdown is inevitable, a recession is not.
Japan’s recovery is naturally more important for this region than is that of Europe. This applies not only to the recovery of output growth—and we must recognize that there has so far been only one quarter of growth—but also to the strengthening of the banking system to ensure the revival of Japanese private sector capital flows to the region. Fortunately, actions taken to recapitalize the banks in the last year are beginning to pay off. The insurance sector too will need strengthening, and corporate restructuring will have to accelerate.
The Next Set of Issues
However, there are many reasons to feel more confident about the recovery than we did four months ago. The recovery is not yet deep-seated, and this is not the time for over-confidence. And there are fresh issues to face. Here are some of the immediate economic issues and questions:
Can growth resume at pre-crisis rates? The short answer is that we do not know. Many of the characteristics of Asian economies that produced the high growth of earlier decades remain in place; among them: highly skilled, hard-working, and high-saving workers and entrepreneurs. Most government policies, and the structures of economies, will be stronger in the post-crisis period than they were before. Capital flows are already returning. It seems now that the very high growth of the last few years before the crisis, to some extent, reflected overheating. Growth in the higher income economies in the region will in any case slow as they approach the levels of the most advanced economies. Most likely, the stronger Asian economies will recover to growth rates well above the world average, but below the remarkable records of recent decades. Some of the weaker economies are likely to take more years to recover, as they deal with the aftermath of the crisis, particularly in the financial sector.
How quickly should fiscal consolidation be achieved? Budget deficits have appropriately been widened—though generally by less than planned during the crisis. But the financial crisis has imposed heavy longer-term burdens on the budget in several countries. Some countries, notably Japan, face large future costs of social safety networks; other countries should improve their social safety nets. Budget deficits will have to be reduced in the medium term, and the efficiency of tax systems enhanced. Fortunately, there is no tradition of large budget deficits in the region, and so governments are likely to seek to restore budget balance within a matter of a very few years. That too is appropriate. The speed at which it needs to be done varies across countries, depending in large part on the size of the explicit and implicit debts that have built up in the last few years.
Sustaining reforms in the financial and corporate sectors, and in governance. Real progress has been made in improving legal systems, prudential regulations, and supervisory frameworks, but these mechanisms still need to be applied rigorously and effectively—and this includes bankruptcy as an essential mechanism in economic restructuring. Transparency will play a key role in all these areas, and here the IMF can help, for example through the experimental transparency reports we are now beginning to prepare in cooperation with the countries concerned.
Dealing with international capital flows. As international capital returns to the region, the challenge is to ensure that the international and domestic macroeconomic and structural frameworks are strong enough to discourage excessive fluctuations in short-term flows, and adequate to deal with the fluctuations that will inevitably occur. This could include market-based measures to discourage short-term capital inflows. It should certainly include stronger domestic policies and financial systems, strengthened prudential regulations in both the capital-originating and the capital-receiving economies, and much better data on the nature and sources of the flows. The role of short-term capital flows and how to deal with them is one of the topics now being examined by a working group of the newly-created Financial Stability Forum.
A word on the exchange rate regime. In the wake of the crisis, we are likely to see more countries adopting flexible exchange rate systems, or, if they fix, doing so in a definitive way, for example, as in Hong Kong, through a currency board. However, this simple dichotomy is unlikely to be the last word and some countries may seek intermediate regimes, for instance a broad target range for the exchange rate, around a central rate that could itself move gradually. Countries that adopt floating rate regimes will have to consider the basis for their monetary policy; increasingly around the world, the benefits of an inflation-targeting regime are being recognized.
Final Reflections
Let me conclude by reflecting on a few broader issues raised by the crises of the last two years. At the height of the crisis, most pundits proclaimed this “the crisis of globalization.” But it is clear from the responses of policymakers that globalization is here to stay, since policymakers unanimously resisted the siren calls to withdraw from the system, close down their capital markets, and retreat into financial isolation. Of course, their reaction only increases the obligation to reform the international financial system.
Accordingly a major effort is now underway to strengthen the architecture of the international financial system. The IMF’s new Contingent Credit Line, the CCL, is designed to offer assurance to countries by offering them contingent financing, which will become available if they are affected by contagion. The CCL is only for countries pursuing good policies and seeking to meet relevant international standards—and it thus enables the IMF for the first time to lend in a precautionary way, outside the context of a crisis, and to provide incentives for good policies. One key issue in the reform of the system is the role of the private sector in the prevention, mitigation and solution of crises. It is also clear that the activities of highly leveraged institutions—an issue that has justifiably concerned policymakers in Hong Kong—need to be looked at very closely. The new Financial Stability Forum, which is itself an important response to the crisis, has a task force addressing this issue, with some Hong Kong officials taking part.
The commitment of the political leadership of a country to reform is essential. Each of the IMF-supported programs in Asia took hold only when the political leadership changed. Public support for the reforms is also essential. This requires both consultation and discussion with a wide spectrum of society, and ensuring adequate social safety nets for the poorest.
Finally, we need also to reflect on the political after-effects of a crisis as deep as this one has been. In the 1980s Latin America went through a profound economic crisis, more prolonged than the Asian crisis will be; the 1980s in Latin America are described as “the lost decade.” But the decade was not entirely lost, for it was during that decade that economic reform finally took hold in Latin America. It was also the decade in which democracy took firm hold in Latin America. Asia is different, for its economic policies before the crisis were much stronger than those of Latin America before its “lost decade.” But the crisis has led to a reconsideration of the tight links among business, government, and the financial sector characteristic of several economies, and it is leading to more transparency in the economy and in economic policy-making. And that transparency too will have wider consequences.
Questions and Answers
Question 1: You talked about Japan, stating some of the structural changes that are necessary. How do you propose that to happen, in that it is so intertwined with society, with its culture and so forth? How do you get them out of the hole so that they can help us, the rest of us in Asia, and out of our hole?
Stanley Fischer: One of the problems in Japan is that this has been a creeping crisis. It has taken so long for the effects to show up in the financial system and for it to become clear that something had to be done. So, they do not have the benefit of what other Asian countries had, which is a clear, sharp crisis with what you say, “I have got to do something.” But Japan has moved a lot in the last year. A year ago this time, they had not done anything with the financial sector. Within a year, they have injected a very large sum into the financial sector. They have set up a financial supervisory committee, which has undertaken highly regarded orders of the seventeen largest banks. They have begun a recapitalization program. The corporate restructuring will get under way. I am sure that statements from friends in Asia will play some role in encouraging Japanese officials to get on with their task. It is always said that you never take advice from anybody but your friends. So, we’ll be relying on you to a considerable extent. We’ll also be offering advice. I believe for some strange reason, it is easier for Japan to take action when prodded from outside. I suspect that the extent of this crisis is shown in the fact that since 1991, growth in Japan, formerly the highest growing industrialized country, has averaged one percent per annum. That fact is hitting home and countries that go through an experience like that will reform at some point; we have seen it, for instance, in New Zealand. It went through that and eventually people say, “Enough, let’s get on with the reforms.” I don’t know when it will be.
Question 2: Not that long ago, the senior minister of Singapore, Lee Kwan Yew, mentioned the fact that if it had not been for the change of sovereignty and the constant level in Hong Kong, he would advocate that we should change the exchange rate system, the floating rate system. At the present moment, what would you advise?
Stanley Fischer: One of the things we said is, whatever exchange rate system you have, there will be days on which you wished you had another one. You don’t judge an exchange rate system by whether at a moment in time it puts you through difficulties. You judge it by how has it done on average over a long period. If I look at the two currency boards-major economies, Hong Kong and Argentina—what I know for sure is that in Argentina, since the institution, the currency board has had its best decade in the twentieth century despite having two recessions during that period. The characteristic of Argentina is that it gets into deep recessions, but it comes out very fast since the board has been there. The nature of the currency board is that you will have more fluctuations, as outside pressures take place, but it does not reduce the average growth rate, at least, the evidence is the other way. I think the answer is that you stick with it and you do not change the exchange rate systems because of a short-run difficulty. You judge how it performs over a long period.
Question 3: You just mentioned the Latin American economy during the early eighties. I remember during that time, everyone talked about the debts, the loans to Latin America. It was so bad that we’ve undermined their stability of the bond in America, and undermined the strength of the US dollar. But now, for the past year, no one has mentioned anything about this problem. Does it mean that you have helped them to write off this debt or all the debt has been repaid?
Stanley Fischer: As you know at the end of the 1980s, the Brady plan went into effect and there was an agreement to write down a lot of the Latin American debt and securitize it in essence. It was done and that continues. The debt problem has not returned in the same way, partly because the lenders have learned a lesson from what happened in Latin America. What you see is that the American banks are relatively less exposed in Latin America than they were before. It turns out, I must say, to my surprise, having had to look at the data lately, the European banks are much more exposed to Latin America than American banks. But there are some countries there with a large external debt. Ecuador is in a crisis right now; it has a significant external debt. But there is no generalized external debt problem in Latin America, I think, because of the lessons in the 1980s, and to some extent because of the write down of the debt at the end of the eighties.
Question 4: How do you evaluate Malaysia’s resort to capital controls? Malaysian officials are claiming some success, but do you think Malaysia’s incipient recovery is due to the course they have pursued, or to the fact that the rest of the region is starting to recover?
Stanley Fischer: I don’t think if you look at countries, that you will see any obvious impact of capital controls on the strength of currencies. Obviously, they have a pegged currency. Other currencies have tended to appreciate a little bit in the period since last September. The fact that they are taking in reserves is the same result as is happening to other countries and similarly with the recovery. Their recovery has actually been a little slower than that of the neighboring countries. But I would say to evaluate the capital controls, it has neither been as bad as we feared nor as good as they claim. What we feared was that they would impose the capital controls but not do any restructuring. That would be a convenient way of just doing nothing. But in the banking sector, they really did get on with doing some amount of restructuring, so that fear of ours was not born out. There is an article in the Wall Street Journal—this morning—on the corporate side saying that it hasn’t moved as far as other countries, so maybe we were justified. The claim that this is what made it possible to stabilize the exchange rate and reduce interest rates—interest rates are higher than their neighbor, Thailand—and so it is not due to the capital controls. You also see them coming off. My guess is that the long term evaluation is that they made relatively little difference and not a very positive one in terms the effect on reputation for a country which will want to continue being part of the international financial system.
Question 5: I think it would be fair to say that the Asian crises were accompanied by currency crises and banking crises. Now I wouldn’t be so naïve as to ask how can one predict banking crises, because by their nature they are unpredictable. In view of the light of the experience in Asia, I would like to ask what are the key indicators that the IMF will be looking at in future to identify countries, in particular, banking systems that are heading into dangerous territory?
Stanley Fischer: These things are sort of embarrassingly obvious, and the problem with them all is whether the data means anything. You look at capital ratios, you look at NPL’s (Non-Performing Loans) and you look at all those things, and the problem is that frequently when they look good, they may not be good. So, there is now between us and the World Bank, we’ve set up a unit, and will be cooperating to do a so-called assessment of financial systems for countries that we have reason to think that have weak systems. We’ll bring with us bank examiners and others, who actually know how these things work, and try to go beyond the macroeconomic data to form an evaluation of what is going on. That too, is part of the ongoing change in the system. There is a very strong emphasis on trying to figure out how strong financial systems are and then getting countries to reform. Finding that a country’s financial system is weak frequently does not lead to any particular outcome. Among the countries of weak financial systems that got into this crisis, there were some that were warned repeatedly about these systems. You know the political linkages in them, and how difficult it is for them to take action. On every case when you see an incipient crisis, the problem is that they say “Okay, guys like you told us that last year and the year before, and nothing happened and you are exaggerating.” That’s it, if you do not want to take action.
Question 6: I wanted to ask about the Contingent Credit Line you spoke about. No country is, as far as I know, has elected to take that; indeed Mexico has arranged a package outside of that arrangement. Can you speak about how you are looking at the CCL and if there may be indeed a stigma attached to that kind of arrangement after the kind of help the IMF has had to offer in this part of the world?
Stanley Fischer: That “stigma line” is one I have heard only out of a few Asian countries and nowhere else. If it is a “stigma” to say, I may be a victim of contagion. Then you are dealing with people who are blind. Almost anybody, however strong, can be a victim of contagion. This is for strong economies that need a variety of standards and which will have access to this money in event they are hit by contagion. Those who criticize it say, “Why would you sign up for this money and admit you may be hit by contagion?” I think that doesn’t make sense. There are, in fact, a number of countries expressing interest, or have expressed interest, and in the Mexican case, they elected, I think rightly so, in their case, to take a normal IMF credit line because they need the money. The contingent line gives you a line of credit; it does not give you the cash until the crisis comes. Mexico needs money now and so it has taken a normal IMF program and not a contingent credit line; you cannot do both.
Question 7: Besides the lines of credit that you mentioned earlier, what are the rewards, what can the IMF do? What is it doing to avoid the inevitable complacency that again you mentioned that accompanies economic recovery, both on an economic and political level?
Stanley Fischer: The only thing we have in addition to the CCL is the surveillance reports, which are annual reports on how economies are doing. There is a debate on whether they should be published. As it is now, they are not published. They are discussed by governments but they are not made available to the public. I believe that if they were made public, they would be more effective. We are now in an experiment in which countries that have volunteered can publish them over the course of the next year and after a year, we are going to look at them to see whether the fears of those opposed to voluntary publication are justified.
They have two fears; fear number one is that we may say things that make it more difficult in the markets. We will be able to evaluate that. The second fear is that we have pretty frank discussions with most countries. Some countries say, “If we know you are going to publish this, then we are not going to tell you what our problems are.” So we’ll also be able to evaluate, we hope, whether the frankness of our discussion with countries is affected.
The surveillance activities, I think, is the most important one. There have been notions that we should go public and issue warnings. For awhile there was a “soccer” thing about the IMF, whether we should go around giving “yellow cards” to countries. That is a very difficult problem. The difficulty is the following. My teacher at MIT, Paul Sorenson, is famous among other things for saying that the stock market has accurately predicted nine of the last five recessions. We have accurately predicted twenty-five of the last ten crises. It’s not clear whether it is the fact whether we issued a warning to the country that made it take action that prevented the crisis, which is our interpretation, or that we were just wrong. But if we were wrong, and that is a possibility, their going public with a “yellow card” for a country that would not actually get into a crisis, puts a considerable responsibility on you.
So, I’m not in favor of the public warning system; I would rather do something a little more subtle and gentle. We have relatively limited ability to make countries take action before crises. One other charge, which I think, bears on this issue—we are often accused by critics of producing “moral hazard” in two ways. One is by letting investors believe that they will be bailed out. That is not what I wanted to talk about. The other is by encouraging policy makers to believe if they get into trouble, the IMF will be there to help them so they may not be as cautious as they want to be. I think that argument is just nonsense. I have never met a policy maker who wants an IMF program or who is particularly encouraged by the thought that if he gets into trouble we’ll show up. That is another incentive, not a positive one, that we provide for good behavior. The plain fact is that in the recent crisis, in the crisis countries, only one of ten central bank governors or finance ministers that were in office on the date of the crisis has survived. The real threat to these guys is that they will lose their jobs as soon as a crisis breaks out. They know that. We don’t create “moral hazards” but I think the fact that we require action to be taken does provide an incentive for countries to stay out of trouble.
Question 8: It was my understanding that in the IMF program, for the countries that were assisted, that you are encouraging them to relax their rules on foreign investment and particularly land ownership in places like Thailand and Indonesia. I wonder if you had any success or see any success in that particular area.
Stanley Fischer: I’m sorry I just don’t know the answer to both parts of that question. I’m not sure that there were measures related to relaxation of rules on land ownership. There certainly is a desire to relax rules on foreign direct investment and conceivably under that heading there may have been something related to land ownership. But I don’t recall the specific details nor do I know what has happened. Incidentally, there has been considerable comment on the fact that we’ve urged the opening up of capital accounts after this crisis in several countries. But to me that is perfectly understandable. What we urged was the opening up of those elements that were good for the long term like foreign direct investment that they have been keeping out. This was a capital account crisis caused at the short end, not at the long end. We’ve been encouraging opening up at the long end, which we would still continue to do.
Question 9: Do you think that if China were to be kept out of the WTO for another prolonged period of time, what would that do to the international financial market? Will it do anything since they’ve been out all these years?
Stanley Fischer: There are good reasons to want China inside the WTO and I expect it will happen in due course. I said that countries have not rejected globalization, and part of the reason for the creation of the IMF and the World Bank is that the global system creates a set of obligations and also creates a system of rights. Membership in the IMF creates a right to access IMF funds in the event of a crisis; similarly, with membership in the World Bank. It would be good for everybody if negotiations can conclude with China coming into the system. It will be good for the Chinese economy to have China obeying the same rules as the others. It will be very good for the global economy. Because above all, if you ask why despite crises, this post-war period since 1945 has been the most remarkable period of economic development in all of human history, the answer is that world trade exploded. That is the reason why we need China into the system to make it operate under the same rules, and I expect it will happen.
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