Chapter

CHAPTER I Main Developments in the World Economy in 1997/98

Author(s):
International Monetary Fund
Published Date:
September 1998
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The dominant developments in the world economy and for the IMF in 1997/98 were the Asian financial crisis and its repercussions. The crisis broke out in July 1997 in Thailand when, following several episodes of exchange market pressure and reserve losses, the authorities abandoned the peg of the baht to the U.S. dollar. The forced exit from the U.S. dollar peg, in turn, raised doubts about the viability of exchange rate arrangements elsewhere. Spillover effects were soon felt in other countries in the region, especially Indonesia, Malaysia, and the Philippines, exposing underlying structural weaknesses in these economies. Measures to tighten liquidity conditions in Indonesia failed to stem the growing exchange market pressures, and the Indonesian authorities allowed the rupiah to float in mid-August. The situation worsened markedly over the next two months and spillover effects spread to other countries. In Hong Kong SAR, strong pressures on the Hong Kong dollar in October led to a surge in interest rates, followed by a substantial equity market decline. In Korea, downward pressures on the won intensified in late October, following the attack on the Hong Kong dollar, and equity prices fell sharply, reflecting diminished confidence about economic prospects and the growing difficulties encountered by the financial sector in rolling over external loans. After making efforts to defend the won, the Korean authorities widened the daily fluctuation band from 4½ percent to 20 percent in late November, and subsequently requested financial support from the IMF (see Chapter V).

The unfolding crisis, which saw exchange rates and equity prices plunge dramatically (Figure 1), was one of the worst in the postwar period. It was centered in countries that had long pursued prudent fiscal policies and enjoyed high saving rates. What went wrong? The key elements, especially in Thailand, were a buildup of inflationary pressures, manifested in large external deficits and inflated property and stock markets; maintenance for too long of pegged exchange rate regimes, which came to be viewed as implicit guarantees of exchange value, encouraging unhedged external borrowing—often at short maturities; lack of timely and relevant data and information; lax enforcement of prudential rules, as well as weaknesses in the institutional structures of supervision in financial systems; government-directed lending practices that led to a sharp deterioration in the quality of banks’ loan portfolios, in turn reducing the scope for raising interest rates; and problems of governance that, together with political uncertainties, worsened the crisis of confidence. External elements also played a role: foreign investors underestimated the risks associated with their search for higher yields during a period of sluggish economic growth in Japan and Europe and low international interest rates, and contagion effects of the crisis led to an excessive devaluation of the affected currencies.

Figure 1Selected Asian Economies: Bilateral U.S. Dollar Exchange Rates and Equity Prices

(U.S. dollars per currency unit; logarithmic scale; January 5, 1996 = 100)

Sources: Bloomberg Financial Market, LP; International Financial Corporation; and Reuters.

1Pegged to U.S. dollars.

Global Overview

The financial turmoil that erupted in southeast Asia in mid-1997 quickly began to take its toll on demand and activity in the affected countries. It also began to have a dampening impact on global growth late in the year and in early 199S. In 1997 as a whole, however, world output growth continued at about 4 percent (Figure 2), with slower growth in Africa, Asia, and the Middle East offset by faster expansion in the industrial countries, the developing countries of the Western Hemisphere, and the countries in transition (Table 1). Growth in the volume of world trade rebounded in 1997 to 9½ percent, matching the expansion of 1995—the most rapid rate for two decades. The acceleration was widely shared between the advanced and developing country groups, but the growth in trade of the transition economies slowed somewhat.

Figure 2World Indicators

(Annual percent change)

1Goods and services, volume.

Table 1Overview of the World Economy(Annual percent change unless otherwise noted)
1994199519961997
World output3.93.64.14.1
Advanced economics3.12.52.73.0
Major industrial countries2.82.02.52.8
United States3.52.02.83.8
Japan0.61.53.90.9
Germany2.71.81.42.2
France2.82.11.52.4
Italy2.22.90.71.5
United Kingdom4.32.72.23.3
Canada3.92.21.23.8
Other advanced economics4.54.33.84.0
Memorandum
Industrial countries2.92.12.52.9
European Union2.92.51.72.6
Newly industrialized Asian economics7.67.36.46.1
Developing countries6.86.06.65.8
Africa2.53.05.53.2
Asia9.69.08.36.7
ASEAN-417.78.17.13.9
Middle Fast and Europe0.73.64.94.4
Western Hemisphere5.11.23.55.0
Countries in transition–7.6–1.3–0.11.7
Central and eastern Europe–3.01.41.52.7
Excluding Belarus and Ukraine3.05.33.63.1
Russia–12.6–2.80.4
Transcaucasus and central Asia–10.2–4.31.52.2
World trade volume (goods and services)9.39.56.69.4
Imports
Advanced economics9.78.96.48.6
Developing countries7.111.99.312.1
Countries in transition7.818.37.65.4
Exports
Advanced economics8.88.85.99.8
Developing countries13.210.68.710.8
Countries in transition8.312.34.93.5
Commodity prices
Oil2
In SDRs–7.81.924.3–0.9
In U.S. dollars–5.58.018.9–6.0
Nonfuel3
In SDRs10.82.13.11.6
In U.S. dollars13.68.2–1.3–3.7
Consumer prices
Advanced economies2.62.52.42.1
Developing countries50.721.713.78.5
Countries in transition268.4124.141.427.8
Six-month LIBOR (in percent)4
On U.S. dollar deposits5.16.15.65.9
On Japanese yen deposits2.41.30.70.7
On deutsche mark deposits5.34.63.33.4

Indonesia, Malaysia, the Philippines, and Thailand.

Simple average of spot prices of U.K. Brent, Dubai, and West Texas Intermediate crude oil. The average price of oil in U.S. dollars a barrel was $19.18 in 1997; the assumed price is $14.59 in 1998 and $15.94 in 1999.

Average, based on world commodity export weights.

London interbank offered rate.

Indonesia, Malaysia, the Philippines, and Thailand.

Simple average of spot prices of U.K. Brent, Dubai, and West Texas Intermediate crude oil. The average price of oil in U.S. dollars a barrel was $19.18 in 1997; the assumed price is $14.59 in 1998 and $15.94 in 1999.

Average, based on world commodity export weights.

London interbank offered rate.

Associated with the Asian crisis was a dramatic drop in net private capital flows to emerging market economies (Table 2). Such flows had reached a record $240 billion in 1996, with Asia attracting more than 40 percent of the total. After rising further in the first half of 1997, net flows fell steeply, as the crisis in Asia deepened, and for the year as a whole were about $70 billion less than in 1996. Net flows to the developing countries of Asia fell by more than $60 billion to about S40 billion—the lowest inflow since 1992. The developing countries of the Middle East and Europe saw a smaller decline in inflows, while flows to the Western Hemisphere, Africa, and the countries in transition actually increased. In the first quarter of 1998, net capital inflows to emerging market countries remained close to their already reduced levels of late 1997.

Table 2Net Capital Flows to Developing Countries, Countries in Transition, and Newly Industrialized Economies1(Billions of U.S. dollars)
1984–8921990–9621994199519961997
Total
Net private capital flows315.2148.1160.5192.0240.8173.7
Net direct investment12.963.184.396.0114.9138.2
Net portfolio investment4.754.187.823.549.742.9
Other net investment–2.530.9–11.772.576.2–7.3
Net official flows23.915.3–2.534.9–9.727.3
Change in reserves4–13.8–81.2–77.2–120.5–115.9–54.7
Developing countries
Net private capital flows318.2131.2136.6156.1207.9154.7
Net direct investment12.156.875.484.3105.0119.4
Net portfolio investment4.249.385.020.642.940.6
Other net investment1.925.1–23.851.260.0–5.3
Net official flows25.815.69.127.4–3.415.8
Change in reserves45.8–55.7–42.4–65.6–103.4–55.2
Africa
Net private capital flows33.64.410.613.84.58.9
Net direct investment1.12.93.64.25.37.7
Net portfolio investment–0.8–0.20.51.4–0.32.6
Other net investment3.31.66.58.1–0.6–1.3
Net official flows5.17.18.15.26.56.7
Change in reserves40.2–1.9–4.4–1.4–6.4–11.3
Asia
Net private capital flows313.055.963.191.8102.238.5
Net direct investment4.532.243.449.758.555.4
Net portfolio investment1.56.811.310.810.2–2.2
Other net investment7.016.98.331.333.5–14.7
Net official flows7.78.46.25.19.317.7
Change in reserves4–2.1–29.0–39.7–29.0–48.9–17.2
Middle East and Europe
Net private capital flows31.725.215.514.820.716.1
Net direct investment1.13.04.25.14.35.1
Net portfolio investment4.412.812.58.47.96.8
Other net investment–3.89.4–1.21.38.64.2
Net official flows4.8–1.8–1.2–4.8–5.8–1.3
Change in reserves47.2–6.4–3.1–9.4–21.2–14.3
Western Hemisphere
Net private capital flows3–0.245.747.435.780.591.1
Net direct investment5.318.724.325.336.951.2
Net portfolio investment–0.929.960.6–0.125.233.5
Other net investment–4.6–2.8–37.510.518.56.5
Net official flows8.21.8–4.022.0–13.4–7.3
Change in reserves40.5–18.44.7–25.9–27.0–12.3
Countries in transition
Net private capital flows3–1.012.818.429.821.334.5
Net direct investment–0.26.35.413.213.118.2
Net portfolio investment2.04.12.92.27.3
Other net investment–0.84.68.913.65.99.0
Net official flows0.20.5–11.08.4–5.50.8
Change in reserves4–3.6–7.8–8.5–35.90.4–6.2
Newly industrialized economies5
Net private capital flows3–2.04.15.56.111.7–15.4
Net direct investment1.00.13.5–1.5–3.20.6
Net portfolio investment0.52.8–1.20.04.6–5.0
Other net investment–3.61.23.27.610.3–11.1
Net official flows–2.0–0.8–0.6–0.9–0.810.7
Change in reserves4–16.0–17.7–26.3–19.0–12.96.7

Net capital flows comprise net direct investment net portfolio investment, and other long- and short-term net investment flows, including official and private borrowing.

Annual averages.

Because of data limitations, “other net investment” may include some official flows.

A minus sign indicates an increase.

Hong Kong SAR, Korea, Singapore, Taiwan Province of China, and Israel.

Net capital flows comprise net direct investment net portfolio investment, and other long- and short-term net investment flows, including official and private borrowing.

Annual averages.

Because of data limitations, “other net investment” may include some official flows.

A minus sign indicates an increase.

Hong Kong SAR, Korea, Singapore, Taiwan Province of China, and Israel.

The sharp declines in private capital flows to emerging market economies in Asia, although cushioned to some extent by an increase in official financing flows, required substantial adjustments in these countries’ external positions. For the Asian developing countries, taken together, the current account deficit narrowed by almost $30 billion in 1997. And by early 1998, the countries most affected by the crisis—Indonesia, Korea, and Thailand—were each running current account surpluses. In 1997 as a whole, a widening of current account deficits among a number of Latin American countries, reflecting the increase in foreign direct investment in the region, was the main counterpart to the narrowing of deficits in the Asian emerging markets (Table 3). In late 1997 and early 1998, however, a number of advanced economics—most notably the United States—and the oil-exporting countries began to show signs of deteriorating current account balances.

Table 3Selected Economies: Current Account Positions(Percent of GDP)
199519961997
Advanced economies
Major industrial countries
United States–1.8–1.9–2.1
Japan2.21.42.2
Germany–1.0–0.6–0.3
France0.71.32.7
Italy2.33.22.9
United Kingdom–0.5–0.10.3
Canada–1.00.4–2.0
Other advanced economics
Australia–5.6–4.0–3.4
Austria–2.0–1.8–1.8
Finland4.13.85.3
Greece–2.1–2.6–2.9
Hong Kong SAR1–3.9–1.3–1.5
Ireland2.82.01.8
Israel–5.6–5.6–3.4
Korea–2.0–4.9–2.0
New Zealand–3.7–4.0–7.0
Norway3.37.15.5
Singapore16.815.715.2
Spain0.20.30.5
Sweden2.12.53.1
Switzerland6.97.38.3
Taiwan Province of China2.14.02.6
Memorandum
European Union0.61.11.4
Developing countries
Algeria–5.32.76.7
Argentina–1.5–1.9–3.5
Brazil–2.5–3.1–4.1
Cameroon–0.4–2.4–1.3
Chile–2.1–5.4–5.3
China0.20.92.4
Côte d’lvoire–6.0–4.8–1.5
Egypt2.3–0.30.3
India–1.6–1.2–1.5
Indonesia–3.3–3.3–2.6
Malaysia–10.0–4.9–4.8
Mexico–0.5–0.6–1.8
Nigeria–3.72.40.4
Pakistan–3.4–6.5–6.0
Philippines–4.4–4.7–5.2
Saudi Arabia–4.20.20.2
South Africa–2.0–1.3–1.5
Thailand–8.0–7.9–2.0
Turkey–0.6–1.5–1.7
Uganda–2.5–1.8–0.9
Countries in transition
Czech Republic–2.7–7.6–6.3
Hungary–5.7–3.8–2.2
Poland23.3–1.0–3.2
Russia1.30.5–0.3

Includes only goods and nonfactor services.

Based on data for the current balance, including a surplus on unrecorded trade transactions, as estimated by IMF staff.

Includes only goods and nonfactor services.

Based on data for the current balance, including a surplus on unrecorded trade transactions, as estimated by IMF staff.

Consumer price inflation declined further in each of the main country groups in 1997 (see Figure 2). The decline was helped by the weakness of primary commodity prices, including those for oil. In early 1998, oil prices fell further; indeed, by April 1998, in SDR terms, oil prices were about 31 percent lower than a year earlier, while non-oil commodity prices had fallen by 20 percent over the same period. To some extent, the declines reflected the reduced demand for commodities in the countries embroiled in the Asian crisis; the sharp depreciation of these countries’ currencies may also have led to reductions in the foreign currency prices of their commodity exports.

The redirection of financial flows toward the mature markets following the onset of the crisis, together with prospects for lower inflation, contributed to significant declines in medium- and long-term interest rates in the industrial countries in late 1997 and early 1998—in some cases to 50-year lows. This easing of financial conditions, particularly in North America and in western Europe, contributed, in turn, to further gains in equity markets, with many indices reaching new peaks. These developments helped support the growth of domestic demand in industrial countries at the same time that net exports began to he adversely affected by the Asian crisis.

In foreign exchange markets, after considerable initial strengthening during 1997/98, the yen experienced strong selling pressures for most of the period, reflecting market concerns about progress in Japan’s economic recovery. After falling to ¥127 per dollar at the end of April 1997, the yen rebounded sharply in May and early June to reach a high of¥110. With the recovery losing momentum by midyear and with concerns about the domestic financial sector, the yen subsequently weakened anew; by the end of April 1998, it had depreciated to ¥132 per dollar. Although the deutsche mark depreciated further against the dollar during 1997 and in early 1998, the depreciation in nominal effective terms was moderate. The pound sterling rose steeply in 1997 and in early 1998, owing mainly to short-term cyclical factors.

Advanced Economies

Cyclical divergences remained sizable among the advanced economies in 1997. Economic activity was strong in the United States and the United Kingdom, with both economies operating close to capacity and unemployment rates at their lowest in many years. The major economies of continental Europe saw a strengthening of growth in the second half of 1997 and in early 1998, but significant margins of slack remained in most of these countries. The Japanese economy faltered after the first quarter of 1997, then slipped into recession in the fourth quarter of the year, with output contracting in the first quarter of 1998 by 5.3 percent at an annual rate. The impact of the Asian crisis on the advanced economies varied depending on two main factors. The first was the importance of trade and financial links with the crisis economies; these links were generally closest in the Asia-Pacific region.3 The second was the economy’s starting position. The dampening effects of the crisis had a relatively large adverse impact on Japan, where activity and confidence were already weak; by contrast, these effects most likely helped contain inflationary pressures in countries facing the risk of overheating.

After a strengthening of growth in 1996 following four years of weak recovery, self-sustaining growth seemed to be taking hold in Japan in the early part of 1997. But activity declined sharply in the second quarter and picked up only weakly during the remainder of the year. The loss of growth before the middle of the year was attributable primarily to domestic factors, including an increase in the consumption tax in April 1997, cuts in public spending, and financial sector fragility. In the latter part of the year, concerns about the Asian crisis and about the domestic financial sector, together with a renewed softening of equity prices, contributed to continued weakness in domestic spending. For the year as a whole, GDP grew by ¾ of 1 percent. The Japanese authorities responded to these developments by announcing a large fiscal stimulus package in April 1998 and by taking steps to address banking problems, including making public money available to strengthen deposit insurance and boost bank capital. Nevertheless, uncertainties remained about how the banking sector measures would be implemented. In July 1998, the Japanese authorities announced a series of further banking sector initiatives in a Comprehensive Plan for Financial Revitalization, including a “bridge bank” facility intended to facilitate the resolution of failed institutions and measures to strengthen bank supervision and increase transparency.

In the other advanced economies in the Asia-Pacific region, cyclical positions were generally stronger than in Japan when the Asian crisis erupted. In Australia, growth strengthened during 1997 against a background of subdued inflation, a budget near balance, and a reduced current account deficit. Partly as a result of the Asian crisis, however, the Australian dollar depreciated substantially against the currencies of other industrial countries late in the year. In Hong Kong SAR, by contrast, competitiveness deteriorated as a result of regional currency depreciations, and interest rates rose sporadically to relatively high levels in the face of intermittent pressures on the currency. These developments, together with the effects of the regional crisis on trade and confidence, rapidly reduced the overheating pressure that had emerged in early 1997 and led to a sharp contraction of activity in early 1998. As in Hong Kong SAR, a strong financial sector helped limit the contagion of the regional crisis in Singapore and Taiwan Province of China, although in both significant currency depreciation and marked increases in domestic interest rates occurred.

The advanced economies of North America and Europe were less adversely affected by the Asian crisis. U.S. economic performance in 1997 was exceptionally strong, with GDP growing at 3¾ percent, the fastest growth in nine years. Furthermore, inflation in terms of the GDP deflator was the lowest in 32 years, unemployment fell to its lowest level in 24 years, and the federal budget was virtually in balance for the first time since the early 1970s. The strength of the U.S. economy provided essential support for global growth in the face of the Asian crisis. The weakening of external demand associated with the Asian crisis, and the strength of the U.S. dollar, dampened potential inflationary pressures in the U.S. economy and shifted the balance of arguments against monetary tightening in late 1997 and early 1998. Canada also experienced strong growth in 1997, but with significant slack remaining, inflation eased further. A considerable widening of the current account deficit, in part owing to weak global commodity markets, contributed to downward pressures on the Canadian dollar. Official interest rates were raised in late 1997 and in January 1998, mainly to offset the consequences of the currency depreciation for monetary conditions.

European countries’ cyclical positions continued to diverge notably in 1997 and early 1998. In the United Kingdom, output grew by 3¼ percent in 1997, and unemployment fell by year-end to 5 percent—a 17-year low. In Germany, France, and Italy, growth strengthened moderately in 1997 after faltering in the two preceding years. Unemployment rates remained high in all three countries but declined somewhat in France beginning in mid-1997 and in Germany in early 1998. In Germany, growth was driven mainly by continued buoyancy in exports; however, machinery and equipment investment and, subsequently, demand for consumer products picked up. The recovery in France, which also relied heavily on exports, became better balanced, with a pickup in domestic demand emerging in the second half of 1997. Despite a large fiscal correction, growth in Italy also firmed in 1997, with the pickup sustained by a recovery of private consumption, a strengthening of export growth, and a replenishment of inventories. Inflation was less than 2 percent in Germany, France, and Italy in 1997.

Elsewhere in continental Europe—Denmark, Finland, Ireland, Luxembourg, the Netherlands, Norway, Portugal, and Spain—economic growth continued strong in 1997after periods of sluggishness; more convincing expansions emerged in Austria, Belgium, and Sweden. In some of these cases, important structural reforms adopted in earlier years underpinned growth, especially with respect to promoting greater flexibility of labor markets. Subdued growth in Switzerland continued a period of stagnation that has spanned almost five years, but activity picked up in the first quarter of 1998. Inflation in these countries remained fairly uniformly low.

In March 1998, the European Commission determined that 11 of the 15 EU member states had qualified to participate in European Economic and Monetary Union (EMU) in 1999. The Commission based its recommendation (which included as input the European Monetary Institute’s convergence report) on its assessment of the countries having met the convergence criteria for 1997 as outlined in the Maastricht Treaty for inflation, public finances, interest rates, and exchange rates. Of the other four EU countries. Den mark, Sweden, and the United Kingdom had indicated that they did not wish to participate immediately in EMU; the Greek government aimed to join EMU in 2001. In March 1998, the drachma joined the exchange rate mechanism (ERM) of the EU, with an announced central parity against the European currency unit (ecu) that implied a depreciation of 12½ percent; at the same time, the Irish pound was revalued by 3 percent in terms of its central parity.

Developing Countries

A number of developing countries experienced contagion in their financial markets from the Asian crisis during 1997, and many others began to feel other economic effects from the crisis around the turn of the year, including generally higher risk premiums on foreign credits. These influences aggravated a number of other problems limiting growth, such as loss of competitiveness, lower commodity prices, and domestic and external imbalances. In the developing countries as a group, economic growth slowed to 5¾ percent in 1997 from about 6½ percent in 1996. The slowdown was significant in Asia, but most marked in Africa (Figure 3). In the developing countries of the Western Hemisphere, in contrast, growth in 1997 was actually stronger than in the previous two years but weakened in the first quarter of 1998. The slower growth was the result of spillovers from the Asian crisis and policy measures to reduce vulnerability to adverse shifts in investor sentiment and to widening current account deficits.

Figure 3Developing Countries: Real GDP Growth

(Annual percent change)

In the Asian region, financial markets in China remained relatively immune to the contagion effects of the crisis, reflecting the country’s appropriate macro-economic policies undertaken since 1993, the fact that its capital inflows consisted mainly of direct investment with limited vehicles for financial speculation, and its large foreign exchange reserves. While China’s real exchange rate appreciated somewhat as a result of the currency depreciations of its Asian trading partners, its trade position remained strong and the current account continued in surplus. The authorities remained committed to not devaluing the renminbi, a policy critical to restoring stability in the region. Also, inflation remained low following the sharp drop in 1997. In India, output growth declined to about 6 percent in 1997 from about 7½ percent in 1996. The rupee weakened against the dollar in late 1997, partly because of spillovers from the regional crisis, but its exchange value was little changed on a real multilateral basis. In Pakistan, the government adopted a program to strengthen macroeconomic policies and implemented structural reforms following the widening of macroeconomic imbalances and the threat of a foreign exchange crisis in late 1996 and early 1997.

In Latin America, consumer price inflation declined in Brazil to 4¼ percent in 1997, while output growth at 3 percent remained much the same as in the previous year. In response to spillovers from Asia, the authorities tightened monetary and fiscal policies significantly in October and November 1997, and thereby restored confidence and halted the drain of foreign exchange reserves. In Argentina, output grew by a robust 8½ percent, while prices remained broadly stable; as in Brazil, financial market pressures emerged in October, with a significant stock market correction and widening spreads on sovereign debt. In Mexico, the Asian crisis led to a marked increase in exchange market and interest rate volatility. A substantial temporary increase in interest rates helped stabilize the exchange rate, but the peso fell against the dollar in February 1998. In Chile, the peso came under pressure in December but stabilized by late January after moderate foreign exchange market intervention and a sizable increase in interest rates.

For the Middle East and Europe region, the direct spillovers from the Asian crisis were limited, with temporary declines in equity prices in some countries and a widening of interest spreads on internationally traded debt. In the Islamic Republic of Iran, real GDP growth slowed to 3¼ percent in 1997 from 4¾ percent in 1996, reflecting stagnant non-oil exports, cutbacks in government capital expenditure associated with a decline in oil revenue, and delays in structural reforms. In Turkey, growth continued close to 7 percent in 1997, while in Egypt successful efforts at macroeconomic stabilization and structural reform in recent years helped growth pick up to 5 percent. Jordan continued to reap the benefits of successful implementation of stabilization and reform policies, with continued robust growth in output, further declines in inflation, and a narrowing current account deficit.

Economic growth in Africa in 1997 was just 3¼ percent. The disappointing outcome mainly reflected the impact on a number of countries of poor weather, declines in commodity prices, and, in a few cases, armed conflicts. Among the largest countries in the region, growth in South Africa slowed to 1¾ percent in 1997, owing to weaknesses in domestic and external demand. Nigeria was also affected by weak domestic demand, worsened by a lack of foreign investor confidence. In Algeria, growth slowed significantly, owing mainly to the impact of drought on agriculture and further delays in the recovery of industrial activity. In Kenya, growth weakened partly as a result of financial market pressures related to political uncertainties. Inflation remained under control in most of the region.

Transition Economies

In 1997, both Russia and the transition countries recorded positive growth for the first time in eight years. For the countries as a group, output grew by 1¾ percent and inflation was reduced to about 27 percent—testimony to the progress since early in the decade with stabilization and reform policies in most countries.

Spillovers from the Asian crisis were most apparent in Russia, Ukraine, and, among the Baltic countries, in Estonia. In Russia, where the ruble came under attack in late October and November, and again in late January 1998, the authorities defended the exchange rate by raising interest rates sharply. There were associated steep declines in the stock market. The pressures arose despite an external current account close to balance; they reflected a persistently weak fiscal position characterized by poor revenue collection, concerns about how the external position might evolve if the fiscal imbalance were not dealt with, and the decline in oil prices. In Ukraine, although 1997 appeared to have brought single-digit inflation and positive growth within reach, inadequate fiscal adjustment led to increased reliance on official short-term foreign borrowing. Coupled with slow progress on structural reforms, this heightened Ukraine’s vulnerability to adverse developments; thus, when the Asian crisis intensified in late 1997, exchange market pressures forced the authorities to tighten monetary conditions sharply. In Estonia, domestic pressures on financial markets, associated with a burgeoning current account deficit, were aggravated by contagion from the Asian crisis. Interest rates rose substantially in October and November 1997, and equity prices, which had earlier risen steeply, dropped sharply.

A number of other transition countries experienced little impact from the Asian crisis in their financial markets or in their access to external finance, despite their openness to international capital markets. While the Czech Republic suffered a currency crisis in May 1997, in part triggered by the events in Thailand, it responded by tightening fiscal and monetary policies. The result was a significant narrowing of the Czech current account deficit, albeit at the expense of slower growth, and the subsequent deepening of the Asian crisis brought only limited further turbulence. Hungary also experienced little exchange market pressure from the Asian crisis, owing in no small measure to the country’s markedly improved fiscal, growth, and trade performance following the implementation of strong adjustment measures since 1995. In Poland, output grew by about 7 percent in 1997, maintaining the solid expansion of almost six years.

The critical importance of adjustment and reform was highlighted particularly sharply in Albania and Bulgaria. The financial crisis in Bulgaria that had begun in 1996 extended into 1997, and output declined for a second consecutive year. In Albania, the crisis that flared up in March 1997 with the collapse of financial pyramid schemes also led to a drop in output during the year. But in both cases, following significant policy improvements, macroeconomic imbalances narrowed and growth resumed toward the end of 1997 and in early 1998. Bulgaria also recorded a dramatic decline in inflation in 1997, with the currency board arrangement introduced as part of the IMF-supported program playing a central role.

3For example, in 1996, trade with the Asian newly industrialized and developing economies represented 5 percent of GDP in Japan, compared with 1½ percent to 3 percent in the major industrial economies of Europe and North America.

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