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Martin Wolf: Same old IMF medicine
TUESDAY DECEMBER 9 1997
The Fund's prescription for South Korea risks sending the corporate
sector into debt and bankruptcy
Like deer, investors graze happily for a while, ignoring the peril of
predators asleep nearby. Then, when startled, they stampede.
These are the skittish beasts that the International Monetary Fund
is trying to cajole back to their wonted east Asian feeding ground.
The question is whether it is doing this in the best possible way.
The answer is no.
The IMF's mistakes have little to do with the scale of the response. The Fund
and the governments supporting it have mustered a great deal of money to
tackle the crisis that began last June: for Thailand, $17.2bn (œ10.2bn); for
Indonesia, front-line financing of $23bn; and, for South Korea, the $57bn
announced last week. The IMF alone has made $3.9bn available to Thailand,
$10.1bn to Indonesia and $21bn to Korea.
But doing something on a spectacular scale does not make the details right.
There are three precise objections to what the IMF is doing.
The first is that, by imposing a damagingly tough squeeze on economic activity
in affected countries, the IMF risks undermining, not restoring, investor
confidence. The second is that by insisting on faster liberalisation of capital
inflows, the IMF may exacerbate financial vulnerability. The third is that these
vast bailouts may encourage further folly, mainly by lenders.
Careful examination of the Asian crisis reveals why these criticisms have force.
This is a calamity that has befallen the private sector. As Joseph Stiglitz, the
World Bank's chief economist, argued in Kuala Lumpur this month, east Asian
countries suffer neither from fiscal profligacy nor high inflation. Savings are
generally well over 30 per cent of gross domestic product. Both the skills and
work ethic of their peoples are impressive. These are outward-looking
economies whose private sectors have demonstrated global competitiveness.
Thus the comparison between South Korea and the former East Germany
made by David Hale of the Zurich group seems absurd: in 1995 Korea's
exports to competitive world markets were a third of its gross domestic
product. Between 1990 and 1995, export volume grew at an average rate of
7.4 per cent. East Germany had no Samsungs.
If these economies have neither been grossly mismanaged nor failed to
generate internationally competitive production, why have they been subject to
such vicious market attack? The chief answer is that they possess significant
financial weaknesses: credit evaluation is virtually non-existent, corporate
accounts are defective, transactions are influenced by personal relations, and
banks and private companies have inadequate equity.
The salience of these weaknesses has been increased by policy errors, notably
adherence to fixed exchange rates, and turbulence abroad, particularly the
strengthening of the dollar against the yen after April 1995 and the earlier
devaluation of the Chinese yuan. Partial integration into a world financial
system unable to evaluate risk either intelligently or consistently has
exacerbated ill effects. Capital first flowed in on a flood tide, then poured out,
leaving devastation in its wake.
The failure of outsiders to foresee problems ahead has been striking. Two
leading credit rating services, Moody's and Standard & Poor's, failed to
downgrade long-term debt ratings of Indonesia, Malaysia or Thailand in the
year and a half to June 1997. Instead, downgradings followed the crisis - and
exacerbated it.
The IMF's task is to restore confidence and encourage needed reforms. But it
is also to avoid imposing an unnecessarily severe squeeze. This last is not just
the Fund's raison d'ˆtre, but economically essential. If the illness is debt
deflation, a significant economic slowdown must make the patient's condition
worse. High real interest rates in highly indebted economies are dangerous.
For the IMF to treat debt deflation as if it were a traditional ill such as high
inflation and fiscal profligacy is little more scientific than for a doctor to bleed
his patients.
Again, when confronting the challenges of financial liberalisation and reform, a
distinction needs to be made between measures to strengthen the robustness
of the financial sector, on the one hand, and liberalisation of financial
transactions, domestic and foreign, on the other. Partial liberalisation of
transactions within unreformed and undercapitalised financial systems has been
at the root of the crisis. Any such combination is a recipe for disaster.
How well, then, do IMF programmes avoid these dangers? Not particularly
well. Just consider the Korean programme:
short-term interest rates are being raised to over 21 per cent, a real rate
of over 15 per cent;
in spite of a devaluation against the dollar of more than 30 per cent over
the past 12 months, monetary policy is seeking to maintain a low
inflation rate of 5 per cent or less;
the inevitable cyclical loosening of fiscal policy is to be offset by a
structural fiscal tightening of 1« per cent of GDP.
The conclusion: however sick Korean companies and banks may be now,
they will soon be sicker.
Turn then to the structural reforms in Korea. Foreign investment in domestic
financial institutions is to be liberalised, as is foreign equity investment. These
are helpful changes. But the decision to open domestic money and bond
markets to foreign investors is highly questionable in current circumstances. As
for proposed elimination of restrictions on foreign borrowings by domestic
corporations, this looks dangerous. The last thing one gives quite-possibly
bankrupt companies is freedom to borrow themselves out of trouble.
These weaknesses are significant enough. Unhappily, there is more. The IMF
may have halted the contagion and could, if its programme works, help restore
the confidence needed for new lending and investment. But it has also helped
bail out foolish investors.
A study from the Washington-based Institute for International Finance,
released last week, shows just how over-optimistic lenders to emerging
markets became between the second quarter of 1995 and the third quarter of
this year.* The risk is that they may return to their old ways too soon.
To be fair to the IMF, there are no easy ways out of a financial crisis, once
started. There is always a trade-off between dealing with the panic, initiating
fundamental reforms and minimising moral hazard.
For this reason, it is even more important to prevent crises in the first place.
For developing countries, the lessons of this one include avoiding exchange
rate pegs, strengthening financial systems and creating effective ways to
restructure company finances. East Asian governments, ever pragmatic, are
likely to learn these lessons swiftly.
Yet lessons do not stop with countries caught out this time. The global
financial system seems vulnerable to manic swings of mood. The
powers-that-be need to ask why crises arise so often and what they can do to
prevent them. The big task is not just to halt the present panic. It is to minimise
the chances of recurrence. But that is a subject for another column.
William Cline and Kevin Barnes, Spreads and Risks in Emerging
Market Lending, Washington, Institute for International Finance,
December 1997. |
