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Lessons from the Asian Crisis:
The View from 1999 Original remarks by Jack Boorman, Director of the Policy Development and Review Department in the International Monetary Fund, on February 5, 1998, hosted by the Capital Markets Research Center of Georgetown University. Updated material provided by Dr. Boorman in February 1999. Copyright 1999.

Let me begin by stating that I have a fairly optimistic view of "the Asian crisis" today. This is the first time in some months I would have ventured such a view. Exchange rates in most countries have stabilized to some degree recently; some have appreciated significantly. Korean stock prices have risen by 50 percent. Stock prices in other countries have risen from 35 to 50 percent from their lowest levels in December and January. These are all hopeful signs. Having said this, I do think we need to remain cautious.

There is a great deal that still remains to be done. Part of the optimism now is because the Korean government has proposed a package to international banks that could extend the maturity of credit lines to Korean banks. This still has to be accepted by the banking community. Before we become too confident, we need greater progress dealing with the severe problems in the financial sector.

There are also political problems, particularly in Indonesia. The questions of succession that surround President Suharto are well known. The depreciation of the rupiah to 16,000 in early January has no economic base; it can only be explained by a lack of confidence in the political regime.

ISSUES

There are three main questions that need to be addressed:

• How did we get into this mess?
• What is the IMF doing to help?
• What lessons should be learned?

We have seen the problem before, in Mexico. In the early 1990s, Mexican officials traveled widely in developing and emerging market countries explaining how these countries could have growing and successful economies like Mexico's. By the end of 1994, the Mexican economy was in shambles. A similar syndrome had developed in Asia over the past few years. In early 1995, in the wake of the Taquuilla crisis, investors looked at Asia and saw high savings rates, high growth rates, low inflation, fiscal surpluses, and high foreign direct investment and concluded that a Mexican style crisis could not occur in that setting.

Another factor is the lack of transparency of the problems in Asia. Mexico's problems were fairly evident: large imbalances in the macroeconomic accounts. That is not the case in Asia. The problems in Asia were not, for the most part, high inflation, nor large current account deficits. The problems were in the financial sector and the corporate sector, problems that are much less visible to observers, including the IMF, credit rating agencies, and investors. Most of the Asian countries had reasonable macroeconomic performance for quite a few years.

Thailand

The exception was Thailand. Thailand was the first to witness severe market pressures. Thailand did have some classic macroeconomic imbalances, particularly a current account deficit of eight percent of GDP. Despite research, no one has yet perfected a system of early warnings for economic crises. I think all would agree, however, that a current account deficit indicates problems.

Over the last few years, Thailand had permitted a highly vulnerable and unstable financing structure to develop, relying more and more on short-term capital inflows. The International Banking Facilities in Bangkok created instruments to encourage larger capital inflows with shorter maturities, even when capital flows had already reached excessive levels. That situation was blurred by very weak supervisory and regulatory standards.

There are many analysts working in Asia, trying to help resolve these problems. One positive effect they are having is to convince everyone that Asian countries have to establish sensible and strict regulatory and supervisory regimes, if they are to avoid the problems we have seen in this episode.

The IMF had been warning the Thais for more than a year about the problems they were facing. Periodically, financial markets were providing the same warning, and attacking the baht. Even some of the credit rating agencies—which have not, in my opinion, distinguished themselves in this episode—had raised some cautionary signals about Thailand. The authorities did not react. By the time they did act, they made the problems worse in several ways.

First, they did not deal with the problems in the financial system. In fact, they did the opposite of what should have been done. When they finally saw how dangerous the situation was in the nonbank financial institutions, they guaranteed all the depositors and creditors in those institutions, increasing the moral hazard problem in the system. In addition, when the baht was under attack last summer, authorities tried to defend it, and, in so doing, committed virtually all their reserves in the forward market.

When the Fund was first called in to help, we were under the impression that Thailand had international reserves of $30 billion. We did not know, however, that Thailand also had nearly $30 billion dollars on the forward book. They had virtually no net reserves and no room to further intervene in the exchange market.

Many of the Thai problems were self-inflicted. But, then the question is: Why did it not stop with Thailand? Indonesia faced pressure late in the summer. Eventually the authorities floated the rupiah. They came to the IMF for assistance in early October. Korea faced pressure in October and November. They requested help only in late November.

Korea

Like the Thais, the Koreans mounted a desperate defense. They did not have a fixed exchange rate, but they did not want the won to go above an exchange rate of 1000 to the dollar. The Koreans did two things. They miscounted the level of their reserves. The Fund was told that Korean reserves were $50 billion. However, that figure included $20 billion that was not usable. So, the reserves were actually $30 billion. By the time the IMF became involved, just before Thanksgiving, Korea had only $7 billion left in gross usable reserves and they were losing those reserves at $1 billion a day. In six days, we negotiated and the IMF Board approved the biggest financial package we have ever had with a country. We did that so that Korea would not default; they were on the verge of facing that reality.

Why didn't we just let them default? Some experts argue that a default would have been good for the international system; this would have promoted self regulation by the banks involved. Both Korea and Indonesia had sound macroeconomic policies. If you look at the typical measures of robustness in a macroeconomic system, they were satisfactory for both of these countries. But, there were problems.

Market Failures

Contrary to the faith expressed in "efficient" markets in so many quarters, I do not believe that markets are always very sophisticated. Technically, of course, they are extraordinarily sophisticated. They are not, however, as affective as they should be at risk assessment or at assuring that risk assessments drive credit decisions. Many individuals and institutions were offering loans to Asian governments and corporations. Many lenders knew less than they should have about their customers. When the crisis was recognized and people began to understand the situation, there was surprise about the structure of the external debt of Asian financial institutions and corporations. Too many discovered too late that the external debt structure was fundamentally unstable. It had only been two years before, when Mexico's troubles began to surface, that everyone had asked "What about Asia?"

Experts had looked at Asia, and at that time the economies looked reasonably stable. In the last couple of years, though, there has been an enormous explosion of short-term, unhedged cross-border borrowing, which has now come to haunt these countries. Most of the borrowing corporations did not bother to hedge their exposure because of their confidence in the exchange rate pegs. Once rates were floated, institutions and individuals rushed to cover their positions, and a self-aggravating cycle began. That was only one of a number of factors.

The second factor was that a speculative bubble had developed. There was a growing awareness of the underlying problems in the banking sectors of many Asian countries. Much of the short-term money flowing into banks in Thailand was loaned to build condominiums and office buildings. Short-term dollar-denominated liabilities funded long-term, fixed rate loans, with collateral that was not worth its book value at the banks. One of the things that is surprising about this is how similar it is to what happened in Japan in the late 1980s and to the U.S. savings and loan crisis of the mid-1980s. The characteristics are very much the same, but not enough was learned from either the Japanese or American experience to prevent a reoccurrence.

Third, besides the problems of the financial institutions, the mismatched maturities and the unhedged positions, these systems were also riddled with special interest operations and political influence.

The fourth factor was devaluation. Once Thailand devalued the baht, that eroded the stability of the exchange rates for the Indonesian rupiah and the Malaysian ringgit, since both compete with the baht in international markets. The competitive pressures moved from one country to another putting pressures on those exchange rates.

Finally, the fifth factor was the role of the authorities. The situations deteriorated because the efforts of the authorities to deal with crises were not very credible in the beginning. Using all of a nation's reserves, down to the last dollar, removes all room for maneuvering. Moreover, the monetary policy response was tepid at best. The central banks did not adjust interest rates sufficiently; they did not use monetary policy the way classic theory dictates.

All of these factors were occurring simultaneously, not just weakening the systems, but weakening them in a self-aggravating way.

IMF Assistance

Given these difficulties, how has the IMF tried to help? The Fund has applied a mix of policy adjustments—adjusting both macroeconomic and structural policies—along with the provision of very large financing. Our operations have brought us to new terrain in both of these areas.

Financing and Policies

On the financing side, with the exception of the commitments made to Mexico, we have never provided the level of resources that we are providing to Asia. The Fund has committed $35 billion to three countries: Indonesia, Thailand, and Korea. In all, $120 billion has been committed by the IMF, the World Bank, bilateral creditors, the Asian Development Bank, and others. This effort has been controversial. Some critics have said that we have provided too much money. Other critics have said that we have not provided enough and that the programs are underfunded.

On the policy side, our work has, in some respects, been fairly traditional. In Thailand, for example, there was a classic macro-imbalance situation with a very large deficit in the balance of payments. So, we called for a tightening of fiscal policy and tight monetary policy. With a current account deficit as large as eight percent of GDP, the public sector had to contribute to the adjustment. Hence, we urged a reduction in the fiscal deficit.

In Thailand, more so than in any operation that we have had before, the focus was on the financial sector. The operations of 58 nonbank financial institutions were suspended, representing half of all the institutions in that sector. In November, after each of these 58 institutions had been examined, 56 were permanently closed. That shows the magnitude of the problems among the financial institutions in Thailand.

In Indonesia and Korea, the situation was different. This was partially due to the fact that the IMF became involved in each of those countries somewhat later—in October in Indonesia and in November in Korea. By that time, the regional context had changed substantially. Consequently, the calls for fiscal adjustment were much more moderate. We asked those two countries to adjust their fiscal position only to make room for the carrying cost of the inevitable financial sector restructuring that would be required. There were requests for a tightening of monetary policy, as well.

The keys, though, in both Indonesia and Korea, were again restructuring and reforming the financial sector. The elements were similar in the two countries. As in Thailand, some insolvent institutions were closed. For weaker institutions, restructuring plans included the demand that owners invest new capital; otherwise, there would need to be government intervention. Moreover, these institutions have been asked to adopt the Basle standards on capital adequacy.

We have recommended much more stringent regulatory and supervisory regimes for all of these countries. Regulatory agencies need to be reorganized, and deposit insurance should be introduced. Other than the former Soviet Republics, where we and they were building from the ground up, the IMF has seldom gotten so deeply involved in the specifics of financial institutions as we have in the current Asian crisis. But, then, we have also never gone into a group of countries where the difficulties in the financial sector were so deep and so widespread.

We have gone one step farther, here—and raised many questions about the role that we are playing—in getting more deeply involved in questions of governance. There is no alternative to level the playing field for investors in each country. In all three countries—Korea, Thailand, and Indonesia—we were dealing with what has come to be called "crony capitalism," the vast network of influence from the political side on economic decisionmaking. It remains to be seen whether or not we can be effective in that area.

It is very difficult to be immersed in the political arena as deeply as is required in these countries. But, we went into it convinced that many of the problems in the financial sector were the direct results of the way business and politics mix in these countries. In Indonesia, for example, many of the banks and the corporations that the banks are financing are owned by the politically well connected. The weakness in the banking system was common knowledge. Our judgment was that the authorities' efforts and our own would be credible only if there was a public agreement with Suharto that he would change this situation, even if it meant affecting the financial interests of those closest to him. None of the market reforms will be effective unless markets perceive that there really is a new way of doing business.

The Fund agreement with Indonesia was reached November 3rd. One of the 16 banks that was closed belonged to one of President Suharto's sons. There were questions at the time about the commitment of the President to the process. Sure enough, two weeks later, a new bank was opened with a new name, located in the same building, with the same staff, and owned by the same younger Suharto. Needless to say, that was all it took for the skeptics to reappear. The rupiah basically collapsed. The IMF had to go back in January to repeat our efforts.

This is now my "two-try" thesis. A similar process evolved in Mexico two years ago. It took us two tries before we had a program that was sufficiently financed and sufficiently credible that it had a positive impact on financial markets. The same thing has occurred in Thailand, in Indonesia, and in Korea. We had to revisit each one of those programs and renegotiate.

Over the last five years, my conviction has grown that countries are like people. When initially confronted with a problem, they deny it. We have seen this repeatedly. You begin dealing with a country that is facing severe economic problems. You talk to the authorities who are the ones who have been implementing policies as these problems have developed. Those same authorities are not about to say, "You're right, there is a problem. I made major mistakes. Now what should I do?"

Rather, too often, there is denial that there is a problem. But, we still try to help, negotiating the best program that we can, obtaining whatever policy adjustments we can, and making judgments about how the markets are going to react and what kind of financing is needed. And, after we go through all that, it sometimes proves to be insufficient.

At times the problems are political: In Mexico, for example, we negotiated a program, and then a new president faced problems in Chiapas. In Thailand, we encountered the collapse of the government and a new government entered in November. In Korea, just two weeks after our program had been negotiated, presidential elections were held. This may have been the best thing to happen. But, the political tension during that time did not help. Nor did the fact that each of the presidential candidates disavowed the Fund-supported program and promised to renegotiate it after the election. During that period, international banks withdrew their credit lines from banks, putting enormous pressure on the Korean financial system.

In Indonesia, we now face a similar problem. There are questions about President Suharto's health, which raises the question of succession. What will happen if he has a heart attack? What will happen if the country faces a political transition? Nobody knows, but everybody is worried. That is what sends the rupiah to 16,000, when it had been 2,500 per dollar only six months ago. Economics do not explain it; only the political situation can.

Moral Hazard

I do get impatient when I read articles about how the IMF is "bailing out" the investors of the world. I think there is a moral hazard issue here, but it is not the one that is being portrayed in the press.

Any owner of a mutual fund in one of these countries knows that they have not been bailed out. The stock markets in these countries have fallen by 60-80 percent in dollar terms. The stockholders are not being bailed out. Bondholders, also, have suffered large losses. The owners of the closed financial institutions have also incurred losses.

Short-term lenders have incurred losses, too. In Korea, we have asked for extension of maturities on short-term debt. The lenders are incurring major losses, especially if they would prefer to be out of that market quickly. Most loans will become one-to-three year claims. That extension has been negotiated with a spread of 250 basis points. If the credit extension is successful, creditors will realize profits.

There is moral hazard in this approach. Addressing any of the questions about moral hazard raises substantive questions about both bankruptcy and sovereignty. Will the United States, for example, be willing to give an institution like the IMF the right to determine that a certain country is in distress and decide or rule that its creditors cannot collect for, perhaps, the next six months until a financial program is developed? Would the IMF have the authority to delay the payments?

Actions and Needs: The View in 1998

These and other ideas are going to percolate for a long time. In the meantime, I am confident that ten years from now the IMF is still going to be an important global institution. There are a number of things that the international community should do.

I will begin with one requirement that may sound trite, but it is critical: data. Public sector and business decision makers did not know enough about the developing situation in a number of Asian countries. Not enough was known about the substantial level of short-term exposure in the banking and corporate sectors. The level of exposure to foreign creditors was underestimated in the Indonesian corporate sector. It turned out to exceed $65 billion. How did $65 billion cross borders without a full accounting of it. The reason is because the data systems are inadequate. And, I have to believe that if the last person, the one lending that last dollar, knew that there was more than $64 billion in line for collection ahead of him or her, that lender might have been more careful.

Data systems need to be constructed and then applied continually to monitor obligations and risks. The Managing Director of the IMF thinks that the IMF should accept this responsibility. In fact, we have developed a data system, called the Special Data Dissemination Standard that can be found on the world wide web (www.IMF.org). This statistical system is established by countries, and computer users can hyperlink from that system to a country's data system. It is easy to obtain information that was not previously available. However, the system is not sufficiently robust.

One limitation of our system, and any other, is that there are not sufficient statistics on short-term exposure. I am not sure how that can be corrected because the financial exposure can change in many ways. As one example, when we were monitoring Korea, a major bank had to find resources quickly to repay a loan. That originally had been a medium-term loan, but there was a "put" in it. When Standard and Poors reduced the credit rating of this bank, the put was exercised and the loan became due. Developing data systems that can capture that kind of change is very difficult, but necessary.

Another suggestion is to disseminate information about both our successes and failures. We dealt with Thailand effectively, and we are proud of that. We made mistakes with Korea. IMF monitoring has worked in some instances but not always. The failures were mainly because we could not convince the policymakers to do what was necessary.

A related question is whether or not the IMF should publicize information when we know something is wrong. Since we have confidential relations with these countries, the answer is not so simple.

Clearly much needs to be done in the banking systems, regulatory systems, and supervisory systems of emerging economies. They are often weak and need to be strengthened. All need to adopt common internationally accepted regulatory and accounting standards, including transparency, and public disclosure.

Lessons Learned: The View from 1999

There are important lessons being learned from the recent crisis in Asia and elsewhere that are likely to bring changes in international financial markets and in certain institutions, including the IMF.

Lesson 1

Open financial markets would work better (1) if they had better, more accurate and more timely information; (2) if that information were taken seriously in the analysis conducted by investment houses, financial institutions and others; and (3) if that analysis worked its way through to the people who do the deals. This proposition is leading to a massive effort to increase transparency and to improve the standards on which data and information are produced and disclosed and on which the private sector, governments, and institutions make decisions.

There is a major effort underway in the IMF, the World Bank, the BIS, IOSCO, the OECD and elsewhere to improve standards and to assure adherence to and accurate reporting under such standards. Core principles for banking regulation and supervision have been drawn up by the Basle Committee on Banking Supervision and are being promulgated to member countries through an intensive effort in the IMF. In a much broader initiative, the IMF has been asked, in the context of its surveillance work with all member countries, to prepare a "transparency report" for each member country that will assess the adequacy of standards and practices in all these areas. This is a major task and we are only just beginning to explore what can be done in this area. But whatever we can do, it will succeed only if (1) the information is made public and (2) financial markets really demand improvement on the part of countries, financial institutions, and corporations that access the capital markets. There has to be a real reward for following such standards and a penalty for not following them—hopefully reflected in the margins paid on market borrowings.

Lesson 2

Open capital markets bring potential enormous benefits to all and especially to developing countries. This is generally agreed among all but the more radical of those discussing the issues. Countries need to take greater care in the process through which they integrate themselves into the global financial markets. Domestic financial institutions—and the regulatory and supervisory systems that oversee them—need to be much better prepared for such integration. Greater care needs to be given to the pace and sequencing of liberalization and integration—both for banks and for the corporate sector. Short term loans cannot be used to finance medium and long term lending. The critical lesson is: open your capital markets, but do it carefully.

These are areas in which we are actively working in the IMF. We are encouraging all countries to adopt the regulatory and supervisory standards developed by the Basle Committee of Bank Supervisors at the BIS. The IMF offers technical assistance along with the World Bank to help countries establish systems that comply with these standards and the IMF employs surveillance of member countries to assess the progress of countries in conforming with the standards.

Policy makers need to resist the temptation to misuse some of the opportunities created by open markets. One particularly dangerous misuse of markets involves the creation of unstable debt structures by governments themselves. A number of countries recently in crisis, such as Russia and Ukraine, financed unduly large budget deficits over an unduly long period of time that led to a level of short-term exposure that proved unmanageable. Too much reliance by governments on short-term financing will result in a structure against which markets can turn with a vengeance when attitudes and expectations change—as, inevitably, they do.

Lesson 3

International capital flows appear to be unacceptably unstable without changes to the system. In particular, short term flows and, particularly, interbank lines are a source of trouble. The structure and incentives under which bank lines operate need to be examined—from the perspective of both creditor banks and borrowing banks.

There is also a need to assure that governments do not inadvertently create a presumption of guarantees in the way they manage either financial or macroeconomic policy. This was a problem in the banking systems and to a certain degree in the exchange rate regimes in all the Asia crisis countries.

Lesson 4

There is a need for automatic stabilizers and better social safety nets to help cushion the effects on the real economy of shocks emanating from the financial system. In all the recent crisis cases, the initial pressures were severely aggravated by a rush to the exits by creditors and by the dynamic processes set in motion by that rush—further devaluations, a further rush to hedge previously unhedged foreign exchange positions, further increases in interest rates to protect the currency, further weakening of balance sheets, a further fall in confidence and into a downward spiral.

In many cases the rush was led or aggravated by short term creditors. For bond holders and equity investors, the exit leads to a price adjustment that can by itself help to stabilize the situation as new investors are attracted. But with short term lines, the creditor banks can simply wait for them to mature.

Proposals

There are a number of proposals to deal with short term credit. There are suggestions that those that exit during a crisis should be able to do so only with a loss of capital—so-called "mandatory haircuts." "Moral suasion" could be more employed to induce a "voluntary" rollover or restructuring of short term claims as occurred in Korea in December 1997 after the situation deteriorated to an unsustainable position.

In critical situations the problem can go well beyond short-term lines and a much broader approach may be needed to stabilize the situation and to provide a vehicle for the country and its creditors to find an orderly process to share the burden of the necessary adjustment.

The international community does not have the necessary mechanisms to assure an orderly process in such circumstances. There is a genuine risk of disruptive litigation that could prevent even the best efforts of the country to reform and to correct its problems. The issue is to prevent creditors from disrupting the flow of export receipts, seizing the country's reserves, or taking other legal action that could disrupt a country's efforts to correct the problems that led to the crisis in the first place.

Suggestions to help deal with such situations would allow internationally issued bonds to contain majority voting clauses, sharing arrangements and other terms that would facilitate negotiations and foster agreement in the event of a need to restructure. These clauses are aimed at helping overcome the "collective action" problem. But it has also been suggested that the international community needs the authority to endorse a stay on payments by a debtor country under certain well-defined conditions. The purpose would be to protect the debtor against litigation for a temporary period to permit an orderly process of negotiation with creditors.

Finally, I would like to discuss a new instrument the IMF has created to help members confronted with a sudden loss of market confidence. It is called the Supplemental Reserve Facility (SRF), which permits much larger lending (no access limit), at shorter maturity (1–1½ years) and higher interest rates (a surcharge of 300–500 basis points) than any of the Fund's earlier facilities. This facility takes the Fund a few steps in the direction of a lender of last resort—even though the Fund has neither the resources nor the authority to serve that function completely.

This is being taken one step further in current discussions following a proposal made by President Clinton in September 1998. Discussion is underway to create a mechanism that could be used by the Fund to commit a, possibly large, volume of resources to a country that may be threatened by contagion from crises elsewhere in the international capital markets—something in the nature of a Contingent Credit Line. The commitment of support from the IMF could have the effect of bolstering market confidence and helping the country ride out the storm. One problem is how to avoid doing this in a way that simply provides an opportunity for private creditors to reduce their exposure. Another question involves balancing the need for a firm commitment regarding the availability of the resources to the country with the country's assurances to the Fund and the official international community that the country will continue to follow appropriate policies.