Crisis in Emerging Market Economies: The Road to Recovery
- Michel Camdessus
- Published Date:
- October 1998
In a world that becomes more global every day, in a world where private business every day plays an increasingly dominant role in innovation, investment, financing, and ultimately human progress, let me tell you how much I appreciate the opportunity to address this transatlantic business council. Of course the timing of your meeting could not have been more appropriate.
We are witnessing wave upon wave of tensions in global financial markets, turbulence that spreads like wildfire from one part of the world to another. Have economic fundamentals changed so suddenly, so substantially, and simultaneously throughout the world? Or is the loss of confidence that was understandable in some, I repeat, some countries, being transferred indiscriminately to all markets, emerging and established alike?
In this volatile situation, calm analysis is more important than ever, remembering that not all markets, not all economies, not all crises, are the same. Nor will the path to recovery, where recovery is necessary, be the same in each case. Market participants—indeed, all of us—need to be discerning, capable of discriminating among economies, aware that when risks turn to reality in one economy, the same course of events does not need to unfold elsewhere, but that all countries, all institutions must read the markets’ messages properly.
Let me start by observing that not all the news of the day is gloomy. Although downside risks have increased in recent weeks in so many places, it should be remembered that the fundamentals of the European and North American industrial economies remain sound. The growth of the U.S. economy is continuing in 1998 without inflationary pressure. A recovery in continental Europe has gained momentum, aided by the imminent birth of the euro.
These economies offer a powerful message to the rest of the world, which remains valid even in turbulent times. Fiscal discipline, supported by a responsive monetary policy within a sound financial system, works. In North America, long-standing budget deficits are turning to surplus, while in Europe the self-imposed discipline of the convergence criteria under the Maastricht Treaty have brought down deficits, many of which seemed entrenched at much higher levels only a short while ago.
By recognizing yesterday that the balance of risks has shifted from inflation to slowdown in demand, the President of the United States here in New York and ministers of finance and central bank governors of Europe and North America, in the context of a Group of Seven declaration, have indeed pledged their commitment to preserve or create conditions for sustainable domestic growth and financial stability, so critical in today’s world environment. So we are at a moment when a credible pro-growth strategy is taking shape—quite a good signal for the world indeed.
Mr. Chairman, you have asked me to focus my remarks tonight on Asia, certainly not because we should downplay the difficult conditions in other parts of the world, but because Asia offers the first rays of hope for resolving the economic crises that now threaten so many countries. In Asia, we find the first countries to experience crisis in 1997, the first to respond, and, although it is not yet widely recognized, the first to be showing some positive results, however tentative and incomplete. The experience of these countries holds out clear hope that serious problems can be avoided in most countries and that seemingly intractable problems in other countries, even Russia, can be resolved given commitment, sound policies, and a steady nerve. This will bring us then to a kind of journey around the world—from Asia to Russia and then to Latin America—concluding by asking ourselves what kind of a new international monetary system could emerge from the present crisis.
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Asia! The origins of its crisis lie in a complex interplay among domestic macroeconomic, structural, institutional, and political factors, strongly connected with developments in the advanced economies and global financial markets.
Reflection on the pre-crisis situation in the Asian countries in mid-1997 points to the buildup in all countries of serious structural problems in the financial and corporate sectors, and to a varying extent, inadequate macroeconomic policies, perhaps most markedly in Thailand, where the crisis started. Overheating, arising from surging private sector demand, was reflected in real estate and stock market bubbles and, in Thailand particularly, in large trade deficits. Pegged exchange rate regimes had been maintained for too long, encouraging heavy external borrowing, including increasing amounts of short-term credit, which created excessive exposure to foreign exchange risk in both the financial and the corporate sectors. Inadequate prudential rules and supervision allowed the quality of banks’ loan portfolios to degenerate quickly.
It would not be appropriate, nevertheless, to attribute the financial crisis in Asia, or indeed in other regions, solely to their policy shortcomings. Conditions in international markets are also highly germane. Private investors were attracted by the high returns in these countries, and there perhaps less inclined to assess carefully the risks, as the track record of these countries seemed to make them less risky than most. This led many to lose sight of the fact that the steady appreciation of the dollar against the Japanese yen from mid-1995 was contributing to a loss of export competitiveness in countries whose currencies were tightly linked to the U.S. dollar. Then the Thailand crisis blew up and its depth led the markets to reassess emerging markets’ risks—a major factor in the broadening of the crisis. The IMF was called for help … always too late indeed.
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The policy programs to respond to crisis in Asian countries had to be speedily designed, to put the proper emphasis on the immediacy of macroeconomic adjustment, and to recognize the sheer magnitude of the structural reforms that had to be initiated from the outset. As a matter of fact, the importance of the structural element is the hallmark of these programs. Within these programs, we can discern three tiers of recovery:
The first tier is to restore stability. As usual, immediate action is needed for countries faced with sudden acute pressure on their balance of payments;
The second tier is to improve soundness. Lost confidence, especially in domestic financial and corporate systems, has to be restored through fundamental institutional changes;
The third tier is to boost efficiency. The approach of “managed development” underlying economic policy, characterized by mechanisms that interfered with market allocation of resources, has become increasingly out of tune with the rigorous demands of our globalized economy. Basic changes in the approach to policymaking, allowing market forces to operate more freely, will be essential. This tier perhaps has been the more controversial due to many misunderstandings on what were at an earlier stage the parameters of the “Asian miracle,” and more than that, due to the fact that questioning this approach was tantamount to challenging many vested interests.
Let us take stock of the major programs supported by the IMF in Korea, Thailand, and Indonesia in terms of these three tiers of recovery. First, with respect to the initial stabilization, as so often is the case, it is the bad news that attracts the headlines. There have been setbacks. Economic activity has contracted sharply, more so than was expected at first. This has been the consequence of a sharp drop in investment as financing has been constrained and unprofitable or inefficient projects had to be cut back. A second factor was the “wealth effect” following sharp declines in stock market prices and exchange rates. A third factor was the fall-off in intra-regional trade, especially with Japan, where stagnation has turned to recession during 1998. This crisis at the heart of the region has been of course central to the difficult process of recovery.
With these contractions have come the social costs: an increasing incidence of poverty, rising unemployment, and steeply rising food prices. But programs have been adapted in response. Let me put some emphasis on this point. These programs have not relied primarily on “traditional” prescriptions of budgetary austerity. Except in Thailand, the initial fiscal adjustment called for was quite small, particularly in order to leave room for financial sector restructuring. Moreover, where necessary we have been perfectly ready to alter—yes, to relax—targets to allow room within public expenditure for targeted programs of poverty alleviation and to stimulate the economy. Indeed in more than one country, the IMF actually had to question the budgetary zeal of the authorities, exhorting them to make more room for social expenditures.
With respect at least to Thailand and Korea, behind these dark clouds, the beginning of a silver lining can be detected. Several developments point to the return of more stable financial conditions that are essential prerequisites for resumed growth, although undoubtedly new risks arise from recent weakening of the external environment:
The external position has strengthened decisively. Current accounts have swung sharply from unsustainable deficit to large surplus and international reserves now exceed pre-crisis levels. The main factor has been a steep fall in imports. But exports have also played a large part and the improvement would have been greater if commodity prices had not fallen steeply, and demand from within the region, especially Japan, had not fallen off.
Currencies are rebounding. After the initial precipitous depreciation, all the currencies of the crisis-ridden countries have shown some appreciation. Even Indonesia, where the decline was steeper and lasted longer, has seen a pronounced appreciation since the depths of its crisis in mid-June. And in Korea, some questions are even being asked about whether the won is appreciating too quickly.
Interest rates are easing. In Korea, Thailand, and the Philippines, interest rates have declined notably as currency pressures have eased. As monetary conditions ease, the prospects for recovery in demand and output are improving.
Inflation has not risen as much as had been feared. Although this reflects very weak demand conditions and a decline in real wages, it means that inflation is unlikely to represent an obstacle to resumed growth.
The objective of the second tier of recovery for which we are working in close cooperation with the World Bank and the Asian Development Bank is to promote the changes that would justify renewed confidence in the soundness of both financial and corporate systems.
In the financial sector, banks were brought under greater scrutiny, with the weakest being closed or restructured, sometimes with public funds. Prudential regulations are being strengthened; so too are standards for accounting, auditing, and disclosure. A more liberal attitude is being taken to foreign banks. The list of changes could be much longer.
The problems of financial systems were in very large measure an outgrowth of fundamental weaknesses in the corporate sector, especially the excessively close relationship between banks, corporations, and the state. This led to an unsustainable situation. So concepts such as transparency, governance in both public and private sectors, and the fight against corruption, have come to center stage. Early on, steps have been taken to work out the massive debt obligations of corporations in a way that is fair to both domestic and foreign creditors. The next stages, already under way, will consist of liberalizing domestic markets, lowering trade barriers, privatization, easing restrictions on entry by foreign investors, and strengthening bankruptcy laws and procedures. But again, time and steadfast implementation will be necessary for results to become evident.
The third tier of recovery will be to increase overall economic efficiency or productivity. For years the Asian tigers’ growth was driven significantly by the massive flow of investment, supported by the impetus from an expanding, and increasingly educated labor force. Looking to the future, we can be quite certain that it will not be back to “business as usual.” True, many familiar features will still be there: the dynamism, the skilled work force, and the traditional Asian propensity to work and save. Nevertheless, capital may well be less abundant or more costly, so that to restore growth to sustainable levels, investment will have to become much more efficient.
Where are we now? Despite the sharp decline in output, there are promising signs of a good start to the “first tier” of policies. Indeed, if the IMF’s mandate were interpreted in a very narrow, traditional sense, as some have suggested it should be, could we not count our task as largely complete? After all, external reserves have been rebuilt, exchange rate stability is being restored, and inflation is at quite low levels. But to stop at this point would not discharge our responsibilities to the countries in crisis or to the world. Only by implementing policies at the second and third tiers, structural and institutional reforms, will it be possible to ensure that the prospects for sustained high-quality growth are restored, that sound institutions and practices are in place, that the external position remains viable in the medium to long term, and, in a word, that the job is done. The Asian countries in crisis have understood that and the IMF has been willing to offer such large financial assistance precisely because they were willing to adopt policies that went far beyond simple stabilization. This is still a matter of some controversy. You will hear perhaps that we are too ambitious; I will suggest to you that it would be illusory to believe that there could be any other way to solve these deeply rooted problems in a sustainable fashion.
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I will dwell no more on these first three victims of the crisis and our three tiers of strategy for them. But let me turn more briefly to a number of other countries or regions that have been the subject of particular concern in recent weeks as financial pressures have intensified.
Japan first, as it must be central also to the solution of the Asian crisis. Japan, as the second largest industrial economy, plays a pivotal role in the world economy, especially in supporting recovery in Asia. At present, we see an economy that is wracked with financial and corporate sector problems, not so different either from those elsewhere in Asia. But its current recession stands in contrast with the imbalances created by years of fever-pitched activity in the Asian “tigers.” In that sense its task is clearer: prompt, resolute action to get its financial system into order is the first urgent order of business. That confidence-building step is essential to underpin the strong fiscal action it may, and indeed should, take simultaneously to stimulate its economy, while pushing its agenda for deregulation, openness, and structural reform.
In Russia, the problems are profound; they have origins far beyond the purely economic domain. In economic terms, the principal causes of the Russian crisis relate to domestic fundamentals; contagion from crises elsewhere—including the impact of lower oil and gas prices—is only part of the story. As a matter of fact, even if in a totally different context, the problems of Russia at the beginning of 1998 were strikingly similar to those which at that very moment were destroying Asian prosperity.
Let me tell you a sad anecdote. In early 1998, back from one of my many trips to Asia, I stopped in Russia to confer with President Yeltsin, and others in economic leadership, to share with them some of the lessons that were already emerging from our experience in East Asia. I told them that a firm monetary stance might well go a long way in stabilizing exchange markets, but that it was neither desirable nor feasible to rely on monetary policy alone for any extended period of time. It was urgent to tackle decisively in Russia the three factors of the “Asian syndrome” that it was also suffering from: continuing macroeconomic deficiency—in Russia, particularly in fiscal policy—weakness in the banking sector, and the pervasiveness of “crony capitalism.” It was another way, using the Asian experience, of restating the priorities we had been insisting on for six years. Now, six months later, the markets have delivered their harsh judgment on Russia’s failure to address any of these critical issues with sufficient effectiveness. Yes, programs have been ambitious and comprehensive; but implementation fell short.
The path to recovery in Russia will need programs at least as comprehensive as those in Asia, containing elements from all three tiers of policies. Russia’s path to recovery is likely to be quite difficult, since Russia needs to restore confidence severely weakened by its decision to unilaterally restructure its domestic debt obligations. Nevertheless, if Russia, like Asia, can begin again to help itself, and do so convincingly, then we stand ready to help. Russia has achieved a lot during the last six years; by far most of the basic elements of its transformation are still in place. Let us hope that the new government will be able soon to start building on these foundations and assembling in the State Duma and in public opinion the broad support that the needed changes will require.
In the meantime, we must continue to shelter the other countries in transition against contagion phenomena. This applies particularly to Ukraine, where despite deteriorating conditions in neighboring Russia, the authorities are showing themselves willing to act, committing to significant reform, and adapting their policies in response to changing conditions. Their recent commitments convinced the IMF that it was appropriate to proceed with a new lending program to support Ukraine’s reform program. A three-year arrangement was approved a few days ago, with commitments from our side of more than $2 billion.
Let’s now cross the Pacific Ocean. Emerging markets in Latin America have been particularly affected by market turbulence after the Russian crisis. This region had responded strongly to the Mexican crisis in 1995, and made significant progress with structural reforms, especially in the area of public finance, and the financial system. In many cases, their economic performance, with a return to low inflation—often in the single-digit range—and stronger external positions, attest to the success of these policies. The region had generally been coping well with the contagion that followed the Asian crisis in 1997. But with global market volatility in recent weeks, coincident with declining oil and primary commodity prices, a number of these economies have come under renewed pressure.
The countries’ response to these developments illustrates two points: first, their determination to undertake appropriate policies; and second, the role that the IMF can play in assisting countries on a regional basis through its policy advice, even before any kind of financial assistance. At my invitation, building upon earlier regional meetings, finance ministers and central bank governors from key countries in the Western Hemisphere attended a regional surveillance meeting in Washington 10 days ago. While stressing that they were not seeking additional financial assistance, the authorities attending the meeting reaffirmed that they were committed to sustaining growth through the pursuit of macroeconomic stability, maintaining open capital markets, and deepening reform efforts. As market pressures intensified in subsequent days, these countries took courageous steps to defend their economies. I need hardly say that these are not the statements or actions of countries about to reverse the positive direction of economic policies. Nor are they the statements of countries that pursue irresponsible economic policies assuming that they will be “bailed out” by the IMF. Nevertheless, it is proper to add that, as I declared last Friday with the unanimous backing of the IMF’s Executive Board, the IMF already has financial arrangements with several countries in Latin America, and according to its mandate, it stands ready to strengthen its financial support and broaden it to other countries, if necessary, to back strong economic programs.
In contrast with this policy stance, I must recognize that there are still, from time to time and from place to place, voices to recommend to countries confronted by a difficult external environment that they yield to the temptation of superficially attractive, populist options, such as unilaterally restructuring debt, imposing new payments restrictions, increasing government intervention in markets, or trying to stimulate expansion by printing money. We know too much, alas, where such a retrograde approach leads: it would reverse years of progress toward more open economic management, and will quickly undermine countries’ capacity to reap the benefits of the global economy.
This being said, it is quite remarkable to see how limited is the impact of these so-called “alternatives” or experiences. The growing majority of countries is striving in the opposite direction, to implement more promising programs based on sound money, budget discipline, state restraint in its economic intervention, structural adjustment, strengthening of financial systems, and promotion of good corporate and public sector governance, in a context of orderly integration in the world economy. These are the only programs we, of course, support. You will be interested to know that more than 80 countries at this very moment are implementing such programs or negotiating them actively with us. These are emerging countries, transition countries, and countries among the poorest, particularly in Africa. Let’s salute their courage and wisdom.
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As you can see, we are far from being a moribund institution, preoccupied with questions about our future. What concerns us is the future of the international monetary system. And this is why, while being so busy with our work as a fire brigade for the world economy, we are devoting attention to detailed reflection on the global or systemic issues that allowed crisis to develop. Thus, looking to the longer term, we have been working with our member governments on proposals to strengthen the architecture of the international financial system, identifying steps that can be taken to minimize the risks of further such crises in the future. This work aims to create a global system that is stable, sound, open, transparent, and fair. This is a tall order. We are working intensely, within the IMF itself, and with other international forums and member governments, to make these ideas operative as soon as possible.
The agenda, a complex one indeed, brings together roles, rights, and obligations for the different constituents of the global economy: governments, citizens, private corporations, and international organizations. Let me give you a snapshot of the work that is in progress at present:
Strengthening the IMF’s surveillance of its members’ policies, especially with respect to financial sector issues and capital flows;
Improving the soundness of financial systems through widespread adoption of consistent standards and practices for regulating and supervising banking systems, securities markets, and other financial institutions;
Strengthening the financial infrastructure through more uniform standards for auditing, accounting, bankruptcy procedures, and payments systems;
Making the golden rule of transparency prevail, by providing for timely and accurate information in the form of both data and more open communication to the markets about economic policy formulation and results;
Defining the principles of good governance in both the public and private sectors;
Continuing firm but orderly progress with freeing capital flows, recognizing that it is a long-term goal for many countries, to be set in the context of properly sequenced financial reform and of a strengthening of macroeconomic balances. As you know, this is a domain for which we received a very clear mandate in Hong Kong to go for freedom and orderly dismantling of capital controls. If anything, contrary to the confusion that seems to have emerged lately, the present crisis encourages us to persevere in this direction;
Developing ways of involving the private sector in forestalling financial crises and in resolving them if they do occur—a domain, I hope, where the private sector will volunteer suggestions, and in which they will not hesitate, if needed, to take action even before more formal or far-reaching arrangements are put in place;
And, the bottom line, promoting a permanent dialogue with governments, aiming to ensure that economic and social policies contribute to improve opportunities for all citizens to participate in and benefit from economic progress. This is the ultimate aim of all our efforts.
Even as the architecture is being reinforced, one urgent task needs attention to enable us to continue with our work: it is a question of resources. The IMF’s tasks are, simply stated, to offer policy advice to all members, and to provide financial support to those members that need it and are prepared to make the necessary policy changes. It is evident that with increased global market turbulence, the Fund needs to be able to remain an effective partner with its members as they confront these challenges. This has a name: it is the increase of our quotas—namely our capital base—a decision involving our 182 members. It is still pending, particularly in the United States. I have no doubt that this decision will be taken promptly, as has always been the case in our history, so enabling the Fund not to save the world—this is not its mission—but to help effectively those who strive to save themselves.
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Mr. Chairman, these remarks have been too long. Let me hope that they may be of some help for this attentive audience in evaluating what this crisis is all about, what is the right track toward recovery, and what kind of new financial architecture we should put in place, so as to hit the ground running as we emerge from this crisis.