Chapter

CHAPTER V The Asian Crisis

Author(s):
International Monetary Fund
Published Date:
September 1998
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As the formative event of the financial year, the Asian financial crisis absorbed a large proportion of the Executive Board’s time. Directors met frequently—at times, daily—to be briefed on and discuss developments in the countries at the center of the crisis and to guide the work of staff and management with those countries’ authorities. IMF-supported adjustment programs, involving very large financial support, for Indonesia, Korea, and Thailand were approved by the Board. The Board also conducted several in-depth reviews—particularly during its World Economic Outlook and International Capital Markets discussions, and in the context of examining the record of IMF surveillance in the region (see Chapter VI)—of the broader questions prompted by the crisis: its origin, the appropriate response of policy, the appropriate role of the international community, and the lessons to be drawn from the experience. This chapter focuses primarily on the Board discussions on these broader issues through the end of the financial year (end-April 1998). Highlights of the IMF’s response to the crisis are detailed in Box 1, and summaries of the evolution of IMF-supported adjustment programs for Thailand, Indonesia, and Korea (updated through mid-July 1998) are at the end of the chapter.

Origin and Evolution

The Asian financial crisis took place against the backdrop of severe financial market pressures in several Asian economies, linked in part to concerns about their weak financial systems, large external deficits, inflated property and stock market values, maintenance of relatively fixed exchange rates, and overdependence on short-term capital flows—which tended to be allocated to less-productive investment. In addition, shifts in competitiveness associated with wide swings in the yen/dollar exchange rate were also a contributing factor. The pressures were most acute in Thailand, where fragilities in the financial sector heightened concerns about the sustainability of the pegged exchange rate arrangement. Spillover effects from the crisis were felt by other countries in the region, notably Indonesia, Malaysia, and the Philippines, In all of these countries, acute exchange market pressures eventually led to the adoption of more flexible exchange rate arrangements and sizable depreciations of their currencies, as well as sharp declines in asset values.

In August 1997, several Directors during the Board discussion stressed the importance of containing external current account deficits and reducing the reliance on foreign borrowing—especially short-term borrowing denominated in foreign currency—to diminish the risk of disruptive changes in market sentiment. In this regard, Directors noted that the adoption of a strong adjustment program by the Thai authorities and the solid demonstration of regional and international cooperation would pave the way for a restoration of confidence and a gradual return to Thailand’s characteristically strong economic performance. Several Directors observed that to restore economic and financial market stability, it was crucial for all countries in the region to pursue sound macroeconomic and structural policies, strengthen financial supervision, and enhance transparency through timely disclosure of economic and financial data.

By the time of subsequent World Economic Outlook discussions, the crisis had deepened and spread to Korea. In reviewing the reasons for the eruption of turbulence and its unexpectedly strong spillover to other countries. Directors noted that a number of elements had played a role. These included, somewhat ironically, the strong economic performance of the affected countries in recent decades, which had helped attract large capital inflows during the 1990s. The inflows had ultimately put heavy demands on economic policies and institutions, including those intended to promote monetary stability and financial sector soundness. The strength of past performance, moreover, was felt by many Directors to have contributed to initial delays in the implementation of remedial action. External influences had also played an important role. The appreciation of the U.S. dollar—to which the currencies of most of these countries were pegged—and slower export market growth had contributed in 1996–97 to worsening the external positions and growth performance of the countries in deepest crisis. Also, international investors, in their drive for higher rates of return, had underestimated the risks in some emerging market economies.

Box 1The IMF’s Response to the Asian Crisis

In seeking to restore confidence in the region in the wake of the Asian crisis, the IMF responded quickly by:

  • helping the three countries most affected by the crisis—Indonesia, Korea, and Thailand—arrange programs of economic reform that could restore confidence and be supported by the IMF. The Philippines’ existing IMF-supported program was extended and augmented in 1997, and a Stand-By Arrangement was approved in 1998;
  • approving some SDR 26 billion of IMF financial support for reform programs in Indonesia, Korea, and Thailand and spearheading the mobilization of some $77 billion of additional financing commitments from multilateral and bilateral sources in support of these reform programs in 1997. In mid-1998, the IMF’s committed assistance for Indonesia was augmented by SDR 1 billion, with an estimated $5 billion from multilateral and bilateral sources. Of the commitments to all three countries, some SDR 18 billion had been disbursed by the IMF by July 23, 1998. (See table.); and
  • intensifying its consultations with other members both within and outside the region that, although not necessarily requiring IMF support, were affected by the crisis and needed to take policy steps to ward off contagion.To implement its response to the crisis, the IMF:
  • used the accelerated procedures established under the Emergency Financing Mechanism and the exceptional circumstances clause to meet the exceptional needs of the member countries in terms of approval time and access. This was followed by close monitoring of performance under the programs on a continuing basis and the approval of a number of adaptations to the original programs in light of developing circumstances;
  • created the Supplemental Reserve Facility to help members experiencing exceptional balance of payments difficulties owing to a large short-term financing need resulting from a sudden loss of market confidence;
  • stepped up coordination with other international financial institutions, notably the World Bank and the Asian Development Bank, and with bilateral donors, to augment international support for the affected countries’ economic reform programs;
  • strengthened its dialogue with a variety of constituencies in the program countries, including consultations with opposition and labor groups and extensive contacts with the press and the public;
  • provided staff support to coordinate efforts by international creditor banks and debtors in the affected countries to resolve the severe private sector financing problems at the heart of the crisis;
  • posted on the IMF website—with the consent of the governments of Indonesia, Korea, and Thailand—their Letters of Intent, describing in detail their IMF-supported programs, so that details of the programs would be readily available to all interested parties; and
  • reinforced means of communication with officials and support for their efforts at consensus building through the appointment of former IMF Deputy Managing Director Prabhakar Narvekar as Special Advisor to the President of Indonesia; the establishment of resident representative posts in Korea and Thailand (in addition to the existing post in Indonesia); and the work of the IMF’s new Asia and Pacific Regional Office (see Chapter VI).
Commitments of the International Community and Disbursements of the IMF in Response to the Asian Crisis, as of July 23, 19981(Billions of U.S. dollars)
CommitmentsIMF

Disbursements
CountryIMFMultilateral2Bilateral3Total
Indonesia11.210.021.1 442.35.0
Korea20.914.023.358.217.0
Thailand402.710.517.22.8
Total36.126.754.9 4117.724.8

IMF commitments to the Philippines are not included.

World Bank and Asian Development Bank.

Bilateral contributions to Indonesia and Korea were a contingent second line of defense.

Estimate; amount of new commitments not finalized as of July 23, 1998.

IMF commitments to the Philippines are not included.

World Bank and Asian Development Bank.

Bilateral contributions to Indonesia and Korea were a contingent second line of defense.

Estimate; amount of new commitments not finalized as of July 23, 1998.

Directors agreed, however, that policy weaknesses in the affected countries had been the most important contributor to the sudden shifts in market sentiment. In particular, inflexible exchange rate arrangements had been maintained for too long—even when fundamentals no longer supported them—constraining the response of monetary policy to overheating pressures, Investors had also viewed pegged exchange rates as implicit guarantees of exchange value, which, together with implicit guarantees of support to the banking sector, had encouraged external borrowing and excessive foreign exchange exposure, often at short maturities. Inadequate banking regulation, supervision, and prudential rules had contributed to the inefficient intermediation of these funds, resulting in fragile balance sheets of many banks and nonfinancial corporations. Excessive government intervention and problems with data availability had also—to varying degrees—impeded market discipline on resource allocation and on the volume of capital investment, further distorting the deployment of capital inflows from abroad as well as domestic financial resource intermediation. Significant delays in confronting the problems and adopting the requisite monetary policy and structural reform measures had compounded the affected countries’ economic difficulties and the associated contagion effects.

Appropriate Policy Response

At their December 1997 discussion, Directors emphasized that the main responsibility for resolving the turmoil in Asia rested with the affected countries. Hesitation in implementing the needed adjustment and reform measures would only worsen the crisis and exacerbate overshooting in financial markets and contagion to other countries. In this context, a number of Directors questioned the adequacy of the commitments of the authorities in some of the affected countries, arguing that this had added to market turbulence. All Directors agreed that bold actions to address key policy weaknesses were indispensable for restoring confidence and preparing the ground for a solid rebound from the current difficulties. They stressed four areas for action:

  • Domestic and foreign investors needed to be reassured that macroeconomic stability would be restored. Directors agreed that the required degree and composition of fiscal adjustment had to strike a balance between several objectives, including the need to contribute sufficiently to current account adjustment and to meet the costs of financial system restructuring, while avoiding excessive compression of domestic demand. Some Directors questioned the need for significant tightening of fiscal policy since the Asian economies in crisis generally did not suffer from fiscal imbalances.
  • Monetary policies had to be kept sufficiently firm to resist excessive depreciation of the exchange rate and its inflationary consequences, while ensuring that domestic demand was not unduly squeezed and the banking sector not overly strained. Some Directors stressed the need for a strong, early monetary tightening to restore market confidence quickly, while the requisite banking and other structural reform measures were getting under way. Directors agreed that as confidence was restored, monetary conditions should be allowed to ease—with a gradual lowering of interest rates—to help support activity, but they emphasized the danger of premature easing. It was important to encourage financial institutions and corporations to roll over external short-term loans in cases where the repayment of such loans risked worsening downward pressures on the exchange rate.
  • Weaknesses in the financial sector needed to be addressed through bold and comprehensive measures to dispel uncertainties. Although it was necessary to ensure adequate protection for small deposit holders, insolvent institutions had to be closed to facilitate an early restoration of confidence. Weak but viable institutions had to be restructured and recapitalized in ways that were fully transparent and did not inappropriately shield creditors and equity holders from losses or exacerbate problems of moral hazard.
  • Public and corporate governance had to be strengthened to enhance transparency and accountability, and data—especially financial and banking sector indicators—had to be provided on an accurate and timely basis.

Directors noted in December 1997 that the prolonged crisis in Southeast Asia and East Asia had raised the prospect that other emerging market countries, which had already experienced some spillovers, could experience an intensification of financial market pressures. While reform efforts had been strengthened considerably among developing countries in recent years, a number of countries remained vulnerable to reversals of market sentiment. The policy requirements in these countries were similar to those in the countries that had already been affected. In addition, several Directors thought that some other emerging market countries should consider whether greater exchange rate flexibility might help to reduce the risk and cost of possible speculative attacks on their currencies. Directors agreed that, whichever exchange arrangement countries chose to follow, protection against currency market turmoil was likely only if it were fully supported by strong macroeconomic policies and robust financial systems.

During their March 1998 discussion. Directors affirmed their support for the programs put in place to restore confidence in the affected countries, including measures to strengthen financial sectors, correct macro-economic imbalances, and improve data availability, transparency, and governance. Such measures were seen as the most effective means of addressing the causes of the crisis, limiting and reversing currency and stock market overshooting, and restoring sustainable growth.

Directors observed that delays in adopting and implementing reform packages had, in some countries, heightened the panic, deepened the crisis, and delayed its resolution. Delays in implementing critical reforms in Indonesia, in particular, had put stabilization and recovery in doubt. Korea and Thailand, in contrast, had made good progress in stabilizing financial markets and in beginning to rebuild confidence through concrete, timely measures backed by the strong resolve and the consistent message conveyed by the authorities. Directors broadly agreed that the Asian crisis countries would record substantial turnarounds in their current account balances in 1998, from deficit to surplus, as domestic demand declined and improved international competitiveness boosted net exports. Nevertheless, many Directors emphasized that the affected countries had to continue to undertake the necessary adjustment, especially in restructuring financial systems.

Role of the International Community

While financial market conditions remained unsettled, a number of Directors emphasized during their December 1997 discussion that the authorities in the major industrial countries should be cautious in considering any further tightening of monetary policy. Most Directors felt that further tightening should be put on hold, particularly given the prospect in most cases of continuing subdued inflation. Some Directors felt, however, that domestic monetary policy should aim solely at dealing with the condition of the domestic economy.

Directors called for resolute action by the Japanese authorities to address the strains in Japan’s financial sector, including through the closure of insolvent institutions, and the well-targeted use of public funds to assist in urgently needed restructuring. Most Directors also called for modest expansionary fiscal measures in Japan to help avoid any further withdrawal of fiscal stimulus until recovery was reestablished. Directors also emphasized the need to speed up deregulation to enhance domestic investment opportunities, thereby reducing Japan’s persistently large external surplus.

Directors welcomed the fact that, despite the seriousness of the issues confronting many of the Asian economies, growth in North America and Europe had been sustained and was likely to provide support for the global economy in the period ahead. This meant that the economies in difficulty would benefit from a relatively favorable external environment. Directors stressed that, given the medium-term growth potential of the countries at the center of the crisis, they could reasonably expect to regain market confidence once their authorities had addressed structural weaknesses—especially in the financial sector.

In discussing the role of the international organizations in helping contain the crisis, several Directors were concerned about the possible moral hazard implications of the current crisis resolution mechanisms. They stressed the importance of ensuring to the maximum extent that IMF financing did not serve to bail out private creditors. The IMF, other international financial institutions, and the official sector should not assume the burden of financial support alone; private sector creditors should play a part as well.

Concerns about the IMF’s ability to contain financial crises and about moral hazard were reflected in the Executive Board’s decision, in December 1997, to adopt the Supplemental Reserve Facility (SRF) (see Chapter VIII). SRF financing carries higher interest rates than are charged on other IMF financing to encourage early repayment, to minimize the risk of moral hazard, and to ensure that only those countries with a compelling need will seek recourse to the facility. In addition, the decision establishing the new facility states that a member using IMF resources under the decision is encouraged to seek to maintain participation of creditors, both official and private, until the pressure on the balance of payments ceases. It also states that all options should be considered to ensure appropriate burden sharing. Similarly, in their February 1998 discussion of IMF policy on sovereign arrears to private creditors (see Chapter VIII), Directors emphasized the need to involve private creditors at an early stage of the crisis to ensure adequate burden sharing and limit moral hazard.

At its April 1998 meeting, the Interim Committee, while noting the difficult issues involved, requested the Board to intensify its consideration of possible steps to strengthen private sector involvement, suggested different mechanisms for meeting this objective, and asked the Board to report on all aspects of its work in these areas at the fall meeting of the Committee.

Early Lessons from Experience

In their regular review of members’ policies in the context of IMF surveillance, Executive Directors drew several major lessons from the Asian financial crisis (see Chapter VI). In addition, during their March 1998 World Economic Outlook discussion, Directors pointed to the need for the international community to make greater efforts to identify emerging vulnerabilities for preemptive action; at the same time, they recognized that it was impossible to detect all incipient banking and exchange market crises. They thought that study of the Asian financial crisis could provide useful inputs for developing “vulnerability indicators” and early warning signals of imminent crises. Some Directors, however, were concerned about the reliability of such indicators in view of the complexity of the elements contributing to crises. They stressed that the recent experience amply demonstrated the importance of accurate and timely provision of information and, therefore, underscored the need for continued improvements in the coverage, timeliness, and quality of financial statistics, including indicators of bank profitability, interest rate spreads, levels of nonperforming loans, and indicators of competitiveness. They also called for further study of the contagion process.

One lesson that Directors drew from the crisis was that countries had to prepare carefully for the liberalization of capital account transactions to enjoy the benefits of access to global markets while reducing the risk of disruption. Important preconditions for successful liberalization were consistent domestic policies, a sound financial system, and the removal of economic distortions, as well as progress in transparency and disclosure on the part of governments and financial institutions. Some Directors suggested that emerging market countries—at least during a period of transition that might have to be relatively long—should adopt market-based safeguards aimed at limiting the exposure of financial and corporate sectors to reversals of short-term capital movements. This would reduce the risk that capital inflows could become a source of difficulty, rather than a benefit.

Some Directors also remarked that, while currency pegs had served many countries well, it was important to weigh the costs and benefits of these arrangements in the future, and in some cases design exit strategies. Some other Directors, however, cautioned, that a move toward greater exchange rate flexibility should not be regarded as a prescription for averting a financial crisis. Attention had to be paid to ensuring the consistency of the overall policy framework in order to maintain confidence and avoid excessive currency depreciation; this included the establishment of an alternative monetary anchor or inflation target and a preemptive strengthening of the banking system.

Thailand, Indonesia, and Korea: Evolution of IMF-Supported Adjustment Programs

Thailand

The Asian financial crisis started in Thailand with the baht coming under a series of increasingly serious attacks in May 1997, and the markets losing confidence in the economy. In the face of these pressures, the authorities ceased on July 2 to maintain the exchange rate peg. And on August 20, 1997, the Executive Board approved financial support for Thailand of up to SDR 2.9 billion, equivalent to 505 percent of Thailand’s quota, over a 34-month period.

The initial program of economic reform featured:

  • financial sector restructuring, focusing first on the identification and closure of unviable financial institutions (including 56 finance companies), intervention in the weakest banks, and the recapitalization of the banking system;
  • fiscal measures equivalent to about 3 percent of GDP, to shift the consolidated public sector deficit into a surplus of 1 percent of GDP in 1997/98, to support the necessary improvement in the large current account deficit, and cover the interest costs of financial restructuring;
  • a new framework for monetary policy in line with the new managed float regime; and
  • structural initiatives to increase efficiency, deepen the role of the private sector in the Thai economy, and reinforce its outward orientation, including civil service reform, privatization, and initiatives to attract foreign capital.

The program was modified in a Letter of Intent on November 25, 1997, in light of the baht’s subsequent larger-than-expected depreciation, a sharper slowdown than anticipated in the economy, and severe adverse regional economic developments. The modifications included:

  • additional measures to maintain the public sector surplus at 1 percent of GDP;
  • establishment of a specific timetable for implementing financial sector restructuring, including strategies for the preemptive recapitalization and strengthening of the financial system; and
  • acceleration of plans to protect the weaker sectors of society.

The program was further modified in a Letter of Intent on February 24, 1998, and again on May 26, 1998, to give clear priority to stabilizing the exchange rate while limiting the magnitude and the negative social impact of the larger-than-expected economic downturn and to set the stage for Thailand’s return to the international financial markets. The modifications provided, among other things, for:

  • accelerating financial system restructuring, including the privatization of the four banks in which the authorities had intervened;
  • adjusting fiscal policy targets from a targeted public sector surplus of about 1 percent of GDP to a deficit of 3 percent of GDP, allowing automatic stabilizers to work, and in part to finance higher social spending;
  • ensuring an adequate availability of credit to help foster an economic recovery, while maintaining a tight monetary stance to support exchange rate stability;
  • improving governance in both the corporate and government sectors;
  • strengthening the social safety net;
  • bringing the legal and regulatory framework, including the bankruptcy law, in line with international standards and consistent with the smooth implementation of corporate debt restructuring and the overall economic program; and
  • further deepening the role of the private sector, including through initiatives to attract foreign capital.

Table 4 shows selected economic indicators for Thailand.

Table 4Thailand: Selected Economic Indicators, as of July 23, 1998
19951996199711998 2
Percent change
Real GDP growth8.85.5–0.4–4.0 to –5.5
Consumer prices (end of period)7.44.87.710.0
Percent of GDP; a minus sign signifies a deficit
Central government balance3.02.4–0.9–2.4
Current account balance–7.8–7.9–2.06.9
Billions of U.S. dollars
External debt82.690.591.889.7
Of which: short-term debt41.137.629.922.8
Percent of GDP
External debt49.149.959.672.5
Data: Thai authorities; and IMF staff estimates. Central government balance data are for financial years (October 1 to September 30).

Estimate.

May 1998 program.

Data: Thai authorities; and IMF staff estimates. Central government balance data are for financial years (October 1 to September 30).

Estimate.

May 1998 program.

* * *

Chronological Highlights

1997
August IIWith negotiations, on an adjustment program well advanced, the IMF convenes a meeting of interested countries in Tokyo; total support pledged for Thailand eventually reaches about $17.2 billion.
August 20The Board approves an SDR 2.9 billion Stand-By Arrangement for Thailand and releases a disbursement of SDR 1.2 billion.
October 17The Board reviews the Stand-By Arrangement under the Emergency Financing Mechanism procedures.
November 25Thailand issues a Letter of Intent detailing additional measures.
December 8The Board completes the first review under the Stand-By Arrangement and disburses SDR 600 million.
1998
February 24Thailand issues a Letter of Intent describing further measures.
March 4The Board completes the second review under the Stand-By Arrangement and disburses SDR 200 million.
May 26Thailand issues new Letter of Intent.
June 10The Board completes the third review under the Stand-By Arrangement, approving a disbursement of SDR 100 million and concluding the 1998/99 Article IV consultation.

Indonesia

The shift in financial market sentiment that originated in Thailand exposed structural weaknesses in Indonesia’s economy, notably the weakness of the banking system and the large amount of unhedged short-term foreign debt owed by the corporate sector. On November 5, 1997, the Executive Board approved financial support of up to SDR 7.3 billion, equivalent to 490 percent of Indonesia’s quota, over the next three years.

The initial program of economic reform envisaged:

  • stabilizing the rupiah by retaining a tight monetary policy;
  • financial sector restructuring, including closing unviable institutions, merging state banks, and establishing a timetable for dealing with remaining weak institutions and improving the institutional, legal, and regulatory framework for the financial system;
  • structural reforms to enhance economic efficiency and transparency, including liberalization of foreign trade and investment, dismantling of domestic monopolies, and expanding the privatization program; and
  • fiscal measures equivalent to about 1 percent of GDP in 1997/98 and 2 percent in 1998/99, to yield a public sector surplus of 1 percent of GDP in both years, to facilitate external adjustment and provide resources to pay for financial restructuring. The fiscal measures included cutting low-priority expenditures, including postponing or rescheduling major state enterprise infrastructure projects; reducing government subsidies; eliminating value-added tax (VAT) exemptions; and adjusting administered prices, including the prices of electricity and petroleum products.

Against the background of a continuing loss of confidence in the Indonesian economy and further sharp declines in the value of the rupiah, owing in part to a lack of progress in implementing the program and to uncertainty with respect to the government’s commit merit to the program, the Indonesian authorities announced a reinforcement and acceleration of the program in a new Memorandum of Economic and Financial Policies on January 15, 1998. key reinforcing measures included:

  • canceling 12 infrastructure projects and revoking or discontinuing financial privileges for the IPTN’s (Nusantara Aircraft Industry’s) airplane projects and the National Car project;
  • strengthening the bank and corporate sector restructuring effort, including the subsequent announcement of a process to put in place a framework for creditors and debtors to deal on a voluntary, case-by-case basis with the external debt problems of Indonesian corporations, the establishment of the Indonesian Bank Restructuring Agency (IBRA), and a government guarantee on bank deposits and credits;
  • limiting the monopoly of the national marketing board (BULOG) to rice, deregulating domestic trade in agricultural produce, and eliminating restrictive market arrangements;
  • adjusting the 1998/99 budget—to provide for a public sector deficit of about 1 percent of GDP—in order to accommodate part of the impact on the budget of the economic slowdown; and
  • taking steps to alleviate the suffering caused by the drought, including ensuring that adequate food supplies were available at reasonable prices.

Subsequently, owing to policy slippages, continuing uncertainty about the government’s commitment to elements of the program, and other developments, the rupiah failed to stabilize, inflation picked up sharply, and economic conditions deteriorated. The government issued a Supplementary Memorandum of Economic and Financial Policies on April 10, 1998, adapting the macroeconomic policies to the deteriorated economic situation and further expanding the structural and banking reforms agreed in January. The envisaged measures included:

  • a substantial strengthening of monetary policy aimed at stabilizing the rupiah;
  • accelerated bank restructuring, with IBRA to continue its takeover or closure of weak or unviable institutions and be empowered to issue bonds to finance the restoration of financial viability for qualified institutions; the elimination of existing restrictions on foreign ownership of banks; and the issuance of a new bankruptcy law;
  • an extensive agenda of structural reforms to increase competition and efficiency in the economy, reinforcing the commitments made in January and including the further privatization of six major state enterprises already listed and the identification of seven new enterprises for privatization in 1998/99;
  • accelerated arrangements to develop a framework with foreign creditors to restore trade financing and resolve the issues of corporate debt and interbank credit;
  • strengthening the social safety net through the temporary maintenance of subsidies on food and other essentials, through support for small and medium-sized enterprises, and through public works programs; and
  • enhancing the implementation and credibility of the program through daily monitoring of the reform program by the Indonesian Executive Committee of the Resilience Council, in close cooperation with the IMF, the World Bank, and the Asian Development Bank; substantive actions prior to approval of the program by the Executive Board; and provision for frequent reviews of the program by the Board.

The government issued a Second Supplementary Memorandum of Economic and Financial Policies on June 24, 1998, after the economic situation was made worse and the economic program driven off track by social disturbances and political change in May. The envisaged measures gave high priority to strengthening the social safety net, comprehensively restructuring the banking system, and repairing the weakened distribution system. They included:

  • increasing social expenditure to 7.5 percent of GDP, with provision for, among other things, food, fuel, medical, and other subsidies (to be phased out after the economy had begun to improve); the expansion of employment-generating programs, supported by the World Bank, Asian Development Bank, and bilateral donors; and aid to students;
  • measures to limit the budget deficit to 8.5 percent of GDP, a level that could be financed with foreign funds, including cuts in infrastructure projects and improvements in the efficiency of state-run operations;
  • rehabilitating and strengthening the distribution system, following the disruption caused by social disturbances, to ensure adequate supplies of essential commodities—including the establishment of a special monitoring unit to identity potential shortages of foodstuffs or distribution bottlenecks;
  • restructuring the banking system by strengthening relatively sound banks—partly through the infusion of new capital—while moving swiftly to recapitalize, merge, or effectively close weak banks, and maintaining the commitment to guarantee all depositors and creditors. The authorities would also establish a high-level Financial Sector Advisory Committee to advise on the coordination of actions for bank restructuring;
  • establishing an effective bankruptcy system, as an essential part of the corporate debt-restructuring strategy envisaged by the June 4 agreement between the government and creditor banks on debt restructuring; and
  • strengthening the monitoring of the economic program.

Table 5 shows selected economic indicators for Indonesia.

Table 5Indonesia: Selected Economic Indicators, as of July 23, 1998
199519961997 11998 2
Percent change
Real GDP growth8.28.04.6–13 to –14
Consumer prices (end of period)9.06.611.680.6
Percent of GDP; a minus sign signifies a deficit
Central government balance0.91.2–0.9–8.5
Current account balance–3.2–3.3–1.81.6
Billions of U.S. dollars
External debt107.8110.2136.1135.0
Of which: short-term debt9.513.418.8
Percent of GDP
External debt53.348.564.5162.7
Data: Indonesian authorities; and IMF staff estimates. Fiscal and external sector data are for Indonesian fiscal years (April 1 to March 31).

Estimate.

June 1998 program.

Data: Indonesian authorities; and IMF staff estimates. Fiscal and external sector data are for Indonesian fiscal years (April 1 to March 31).

Estimate.

June 1998 program.

* * *

Chronogical Highlighs

1997
November 5The Executive Board approves a Stand-By Arrangement for Indonesia authorizing drawings of up to SDR 7.3 billion, and disburses SDR 2.2 billion.
1998
Mid-JanuaryIMF management visits Jakarta to consult with President Suharto on an acceleration of reforms already agreed under the program, after further depreciation of the rupiah.
January 15Indonesia issues Memorandum of Economic and Financial Policies on additional measures.
January 26The IMF welcomes Indonesia’s plans for a comprehensive program to rehabilitate the banking sector and put into place a framework for creditors and debtors to deal, on a voluntary and case-by-case basis, with the external debt problems of corporations.
April 10Indonesia issues a Supplementary Memorandum of Economic and Financial Policies on additional measures.
May 4The Board completes the first review under the Stand-By Arrangement and disburses SDR 734 million.
June 24Indonesia issues a Second Supplementary Memorandum of Economic and Financial Policies on additional measures.
July 15The Board completes the second review of the Stand-By Arrangement, disbursing SDR 734 million, and approves an increase in IMF financing under the Stand-By Arrangement by SDR I billion. The IMF also announces that additional multilateral and bilateral financing for the program will be made available, in part through an informal arrangement among bilateral creditors that involves debt rescheduling or the provision of new money—for total additional financing of more than So billion, including the increase in IMF financing.

Korea

Over a number of decades, Korea transformed itself into an advanced industrial economy. Economic over heating, however, led to an increase in structural problems; in particular, the financial system was undermined by excessive government interference in the economy, close linkages between banks and conglomerates, an inadequate sequencing of capital account liberalization, and the lack of prudential regulation that should accompany liberalization. As the Asian financial crisis spread in the latter part of 1997, a loss of market confidence brought the country close to depleting its foreign exchange reserves. On December 4, 1997, the Executive Board approved financing of up to SDR 15.5 billion, equivalent to 1,939 percent of Korea’s quota in the IMF, over the next three years.

The initial program of economic reform featured:

  • comprehensive financial sector restructuring that introduced a clear and firm exit policy for weak financial institutions, strong market and supervisory discipline, and more independence for the central bank. The operations of nine insolvent merchant banks were suspended, two large distressed commercial banks received capital injections from the government, and all commercial banks with inadequate capital were required to submit plans for recapitalization;
  • fiscal measures expected to yield savings equivalent to about 2 percent of GDP to make room for the costs of financial sector restructuring in the budget, while maintaining a prudent fiscal stance. Fiscal measures included widening the bases for corporate, income, and value-added taxes;
  • efforts to dismantle the nontransparent and inefficient ties among the government, banks, and businesses, including measures to upgrade accounting, auditing, and disclosure standards, to require that corporate financial statements be prepared on a consolidated basis and certified by external auditors, and to phase out the system of cross guarantees within conglomerates;
  • trade liberalization measures, including setting a timetable to eliminate trade related subsidies and an import diversification program, as well as streamlining and improving the transparency of import certification procedures;
  • capital account liberalization measures to open up the Korean money, bond, and equity markets to capital inflows, and to liberalize foreign direct investment;
  • labor market reform to facilitate the redeployment of labor; and
  • the publication and dissemination of key economic and financial data.

As described in a Letter of Intent of December 24, 1997, the program was intensified and accelerated as the financial crisis in Korea worsened and concerns about whether international banks would roll over Korean short-term external debt placed additional pressures on international reserves and the won. Announcement of the strengthened program was accompanied by the start of negotiations between the Korean government and creditor banks to extend the maturities of short-term interbank debts. The measures included:

  • further monetary tightening and the abolition of the daily exchange rate band;
  • speeding up the liberalization of capital and money markets, including the lifting of all capital account restrictions on foreign investors’ access to the Korean bond market by December 31, 1997; and
  • accelerating the implementation of the comprehensive restructuring plan for the financial sector, including establishing a high-level team to negotiate with foreign creditors and reducing the recourse of Korean banks to the foreign exchange window of the central bank.

A Letter of Intent dated January 7, 1998, provided additional details of the Korean government’s external and reserve management strategies and further articulated the financial sector reform program.

In a subsequent Letter of Intent of February 7, 1998, the macroeconomic framework was further revised and the policies that the government intended to pursue for 1998 were set out. These policies, formulated against the background of the January 29 agreement between the Korean authorities and a group of creditor banks on a voluntary debt exchange, included:

  • targeting a fiscal deficit of about 1 percent of GDP for 1998 to accommodate the impact of weaker economic activity on the budget and to allow for higher expenditure on the social safety net;
  • moving forward to implement a broader strategy of financial sector restructuring, having contained the immediate dangers of disruptions to the financial system;
  • increasing the range and amounts of financial instruments available to foreign investors, increasing the access of Korean companies to foreign capital markets, and liberalizing the scope for mergers and acquisitions in the corporate sector; and
  • introducing a number of measures to improve corporate transparency, including strengthening the oversight functions of corporate boards of directors, increasing accountability to shareholders, and introducing outside directors and external audit committees.

In a Letter of Intent of May 2, 1998, the Korean authorities updated the program of economic reform in view of the progress made in resolving the external financing crisis, on the one hand, and the even weaker outlook for economic activity, on the other. Positive developments included the conclusion of the restructuring of $22 billion of Korean banks’ short-term foreign debt, a successful return to international capital markets through a sovereign global bond issue of $4 billion, the shifting of the current account into substantial surplus, and an increase in usable reserves to more than $30 billion. The measures cited in the Letter of Intent included:

  • accommodation of a larger fiscal deficit of about 2 percent of GDP in 1998, in light of weaker growth and through the operation of automatic stabilizers;
  • measures to strengthen and expand the social safety net, including through a widening of the coverage of unemployment insurance and increases in minimum benefit duration and levels, as well as a temporary lowering of minimum contribution periods;
  • formation of an appraisal committee, including international experts, to evaluate the recapitalization plans of undercapitalized commercial banks;
  • publication by August 15, 1998, of regulations to bring Korea’s prudential regulations closer to international best practices, including by strengthening compliance with existing guidelines concerning foreign exchange maturity mismatches; and
  • further phased liberalization of the capital account, including loosening restrictions on foreign exchange transactions, foreign ownership of certain assets, and ceilings on foreign equity investment in nonlisted companies.

Table 6 (previous page) shows selected economic indicators for Korea.

Table 6Korea: Selected Economic Indicators, as of July 23, 1998
1995199619971998 1
Percent change
Real GDP growth8.97.15.5–1 to –2
Consumer prices (end of period)4.74.96.68.2
Percent of GDP; a minus sign signifies a deficit
Central government balance0.30.30.0–1.7
Current account balance–1.9–4.7–1.97.3
Billions of U.S. dollars
External debt119.7157.5154.4163.3
Of which: short-term debt78.7100.068.439.6
Percent of GDP
External debt26.432.534.951.5
Data: Korean authorities; and IMF staff estimates. Data are for financial years (January 1 to December 31).

May 1998 program.

Data: Korean authorities; and IMF staff estimates. Data are for financial years (January 1 to December 31).

May 1998 program.

* * *

Chronological Highlights

1997
December 3The IMF notes the successful conclusion of staff discussions with the Korean authorities and the pledges of support coming from the World Bank, ADB, and countries in the group of potential participants in the supplemental financing support package for Korea.
December 4The Board approves an SDR 15.5 billion Stand-By Arrangement for Korea and releases a disbursement of SDR 4.1 billion.
December 18The Board concludes the first biweekly review of the Stand-By Arrangement and releases a further SDR 2.6 billion, activating the IMF’s new Supplemental Reserve Facility.
December 24Korea issues a Letter of Intent, providing for an intensification and acceleration of its program. The Managing Director announces his intention to recommend to the Board a significant acceleration of the resources available to Korea—in light of Korea’s Letter of Intent and in the context of the progress between Korean and international banks in dealing with Korea’s external debt—and notes that the World Bank and ADB will disburse $5 billion before the year’s end.
December 30The Board approves a request by Korea for a modification of the schedule of drawings, bringing forward part of the amounts originally scheduled for February and May 1998, but without changing overall access to IMF resources, and disburses SDR 1.5 billion.
1998
January 7Korea issues a Letter of Intent describing additional measures.
January 8The Board concludes the second biweekly review of the Stand-By Arrangement and disburses SDR 1.5 billion.
January 29The government, Korean domestic financial institutions, and international banks announce a debt-rescheduling agreement.
February 7Korea issues a Letter of Intent on additional measures.
February 17The Board completes the first quarterly review of the Stand-By Arrangement and disburses a further SDR 1.5 billion.
May 2Korea issues a Letter of Intent describing additional measures.
May 29The Board completes the second quarterly review of the Stand-By Arrangement, disbursing an additional SDR 1.4 billion and concluding the 1998 Article IV consultation.

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