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Ethos Issue 3, Oct 2007
The Asian Financial Crisis in Hindsight
Donald Low
In many cases, policy mistakes on the part
of Asian governments after the crisis had begun and the political
constraints they faced added to the instability and volatility.
When their currencies came under attack, the central banks
of Thailand, Korea and Malaysia mounted expensive but futile
currency defences by intervening in the forward markets. These
did little to reduce pressures on their currencies, but shrunk
their foreign exchange reserves further, causing already jittery
creditors to be even less willing to roll over their loans.
In Indonesia, which suffered the sharpest depreciation of
its currency (of 81% between June 1997 and January 1998),
there was an inherent tension between the vested interests
of the Suharto regime and the structural reforms needed to
restore market confidence. The Indonesian government’s
backtracking on many of the promises it had made under the
IMF programmes further undermined the credibility of its commitment
to reform.
INTERNATIONAL FINANCIAL INSTITUTIONS:
A CASE OF BAD PRESCRIPTIONS?
Much of the subsequent debate on the Asian Financial Crisis
has revolved around whether the remedial policy prescriptions
of the IFIs were largely correct or made the situation worse.
The recurrent theme of the criticisms of the IMF is that it
should have concentrated on reassuring markets instead of
disciplining countries—for instance, in demanding fiscal
austerity from countries that did not have budget problems.4
Critics of the Fund argue that the IMF failed
to understand the panic element in the Asian crisis, and that
its response should have been to focus on providing liquidity,
aided possibly by temporary capital controls (which the IMF
objected to on ideological grounds). Joseph Stiglitz, for
instance, argues that the IMF shared a significant part of
the blame for the onset of the crisis because it had encouraged
capital market liberalisation in emerging economies before
their institutional and regulatory capabilities were sufficiently
developed to manage the large capital inflows. He further
argues that the IMF misdiagnosed the problem and prescribed
the same anti-inflationary strategies that it had applied
in Latin American crises (which had been caused by profligate
government spending and loose monetary policy).5
The problem in Asia was not with the governments’ macroeconomic
policies, but the mounting debts of the corporate sector.6
In this context of insufficient (rather than excess) demand,
the policy prescriptions of fiscal contraction, tight domestic
credit and high interest rates were inappropriate and deepened
the downturn.
Other critics such as Jeffrey Sachs have
also pointed out the IMF’s "poorly thought-out
approach to the banking system" which forced a closure
of weak banks without a comprehensive financial restructuring
plan or measures to strengthen the rest of the banking system,
set off a bank run that undermined the rest of the system,
including healthy banks, and increased the costs of the IMF’s
tight money policy.7
Others point to the IMF’s imposition of wide-ranging
conditions, including those on matters that seemed to have
little to do with financial stability, which may have distracted
attention from the urgent issues at hand.6
In the IMF’s defence, three arguments
must be highlighted. First, it should be emphasised that the
root of the crisis was a loss of confidence, arising from
underlying structural and financial problems as well as a
sudden re-evaluation by investors of the attractiveness of
the country as a place to invest. A developing country gripped
by financial panic and capital flight "does not have
luxury of borrowing more or of cutting interest rates without
worsening the panic."8
To the extent that fiscal probity and tight credit policies
were necessary for restoring confidence, it was not a policy
choice that the crisis-hit countries could have avoided—even
if the tough measures deprived indebted companies and banks
of much-needed liquidity.
Second, it should be noted that the hesitation
and lack of commitment on the part of governments in many
cases were probably more to blame for causing greater market
uncertainty than the supposedly intrusive and inappropriate
reforms prescribed by the IMF.
Third, the crisis was not just a case of
pure panic. Even if panic did amplify the effects of the crisis,
there were serious flaws in the Asian economies, especially
in their financial systems. The IMF could not have acted simply
as a lender of last resort. With its limited resources, "it
cannot offer an open-ended credit line to liquidity-constrained
countries in the same way that the Federal Reserve can for
liquidity-constrained banks".4
AFTERMATH: POLICY LESSONS FROM THE
CRISIS
The Asian crisis raised key questions not just for the economic
policies of emerging economies, but also for the role of the
IFIs in crisis prevention and crisis management. Nevertheless,
calls for their abolition—on the argument that they
first caused the crisis and then exacerbated it—were
largely exaggerated and misplaced. In a world characterised
by increasing economic interdependence and financial linkages,
institutions promoting global governance and economic development
ought to be strengthened, not weakened.
There are, however, fundamental questions
about the appropriateness of the policy prescriptions of the
IFIs, the desirability of the liberalisation policies they
advocated, and how the international financial architecture
might be reformed. There certainly appears to be the case
for the IMF to focus more narrowly on its core mission of
financial stability, rather than to spread its energies and
resources thinly across a wide range of social and developmental
issues. Furthermore, it would be prudent for IFIs to be less
ideological and more pragmatic in their policy prescriptions
in crisis management even if neo-liberal economic prescriptions
are the norm under ordinary circumstances.
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