Chapter 4. Evolution of the Economic Crisis in Emerging Market Economies

International Monetary Fund
Published Date:
September 1999
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The financial crisis in Asia, which began with increasing market pressure on the Thai baht in the first half of 1997, continued to unfold during 1998/99, with the persistence of market turmoil and the depth of the recessions in the affected Asian countries exceeding initial expectations. Political instability, policy reversals, and related social and economic disturbances in Indonesia in May 1998 hindered progress there. At the same time, the further weakening of the Japanese economy had a large negative impact on demand in the region and on international financial market sentiment.

Although initially centered mainly in Asia, the crisis took on a more global character in August 1998, when Russia, faced with mounting market pressures, devalued the ruble and unilaterally restructured its domestic government debt. Subsequently, most emerging markets—and notably Brazil—temporarily lost access to private financing, amid fears of a global credit crunch.

Toward the end of 1998, a measure of calm was restored to financial markets, owing in part to policy programs supported by the international financial institutions. With continued progress on stabilization and reform in the Asian crisis countries implementing IMF-supported programs, currencies strengthened significantly—particularly in Korea—allowing monetary policies to be eased. The Russian authorities engaged in a dialogue with IMF staff following the August 1998 crisis; in late April 1999, they reached a tentative understanding on an economic program that could provide a basis for IMF financial support—which was to be submitted to the IMF’s Executive Board following Russia’s implementation of a number of policy measures. In Brazil, concern began to grow in late 1998 over the strength of political support for the government’s fiscal program, leading to increasing pressures on the real and, in mid-January 1999, to a large devaluation and the end of the crawling peg exchange regime. Measures by the government to strengthen the fiscal program, together with a large increase in interest rates, helped strengthen confidence both in Brazil and abroad in the government’s resolve to carry out its program Subsequently, economic and financial conditions improved significantly.

The IMF’s responses to the Asian crisis, and to those in Russia and Brazil and other emerging markets, absorbed a good deal of time in 1998/99. The Board met frequently to evaluate progress in the Asian countries undertaking IMF-supported reform measures (see Box 1), and in December 1998 it discussed a staff assessment of the IMF’s response to these countries’ crises.5 That assessment is covered below and is followed by brief descriptions of developments in Russia and Brazil during the financial year and the IMF’s response to them. In addition to Board discussions of these country situations, Directors also considered issues surrounding the forestalling and resolution of financial crises at discussions of the world economic outlook, international capital markets, and on various aspects of strengthening the architecture of the international financial system (see Chapters 2, 3, and 5).

IMF-Supported Programs in Asian Crisis Countries

During the year, the IMF published the first systematic, albeit preliminary, internal assessment of the policy response to the Asian financial crisis of 1997–98, focusing on Indonesia, Korea, and Thailand. The Asian financial crisis, according to the staffs assessment, differed from previous financial crises in that it was rooted primarily in financial system vulnerabilities and other structural weaknesses in the context of an unprecedented move toward financial market globalization. Conventional fiscal imbalances were relatively small, and only in Thailand were significant real exchange rate misalignments evident. Despite differences in specific aspects of the crisis in Indonesia, Korea, and Thailand, all three shared weaknesses in financial systems, stemming from weak regulation and supervision and (to varying degrees) a history of heavy governmental involvement in credit allocation, including through government guarantees; these were reflected in the misallocation of credit and inflated asset prices. Another severe common weakness was large, unhedged, private short-term foreign currency debt in a setting of limited exchange rate flexibility and a highly leveraged corporate sector; in Korea and Thailand, this debt was mainly intermediated through the banking system, while in Indonesia, the corporations had heavier direct exposures to such debt.

Box 1Asian Crisis Countries: Developments and IMF Response Through the End of April 1999

Following is a summary of developments in the three Asian crisis countries and the IMF’s response to them during 1998/99.


Indonesia’s reform program, supported by an IMF Stand-By Arrangement, fell off track because of policy reversals, increasing macroeconomic turmoil, and financial system collapse in the context of severe civil unrest, which led to the resignation of President Suharto on May 21, 1998. Production, exports, and domestic supply channels were disrupted and banking activities paralyzed. The rupiah hit an all-time low of Rp 16,745 against the U.S. dollar in mid-June, with a cumulative depreciation of 85 percent from June 1997. By July 1998, the time of the Board’s second review of the IMF-supported program, major dislocations to economic activity were evident.

Restoration of the distribution system and strengthening of the social safety net became immediate priorities. Bank-restructuring plans were strengthened to deal with the deteriorating conditions in the financial system, and further steps were taken to facilitate corporate debt restructuring. In view of the deep-seated nature of Indonesia’s structural and balance of payments problems, the Executive Board on August 25, 1998, approved the authorities’ request to cancel the Stand-By Arrangement and approved an Extended Fund Facility Arrangement. Subsequently, on March 25, 1999, the Board completed the fourth review under the EFF and augmented the program by SDR 714 million (about $1 billion). As of the end of April 1999, policy implementation was generally satisfactory and Indonesia had met the major macroeconomic targets under the program for 1998–99, although progress with financial and corporate restructuring was less rapid than had been hoped. Market sentiment remained fragile, partly reflecting continuing structural problems, political uncertainties, and civil unrest.


Korea’s economic reform program, supported by an IMF Stand-By Arrangement, remained on track during 1998–99, with strengthened market confidence in the new administration’s commitment to reforms. As market conditions stabilized, the government successfully launched a sovereign bond issue, capital began flowing into the domestic bond and stock markets and Korea significantly rebuilt its usable reserves. By July 1998, the won had appreciated against the U.S. dollar, permitting the authorities to reduce interest rates to precrisis levels. Structural reforms emphasized the rationalization and strengthening of the banking sector, as well as corporate restructuring. During the year, Korea began repaying loans taken at the onset of the program in December 1997. As of the end of April 1999, the economy showed signs of emerging from the severe downturn of 1997–98, with economic data pointing toward a modest recovery, the pace of which was expected to pick up during the year.


The Thai baht, which depreciated substantially in 1997, began to strengthen in February 1998. Monetary policy initially continued to focus on the exchange rate, with interest rates being maintained at a high level until evidence of a sustained stabilization emerged; then, from around mid-1998, rates were lowered substantially to precrisis levels or below. Fiscal policy was also relaxed to support economic activity. Additional measures to strengthen the social safety net were announced, and the approach to financial and corporate restructuring was elaborated and broadened significantly. In April 1999, the IMF completed a sixth review by the Stand-By Arrangement; as a result, Thailand could borrow an additional $500 million from bilateral and multilateral sources, with the IMF contributing SDR 100 million (about $135 million). The additional assistance resulted from Thailand’s good policy implementation under the economic program supported by the Stand-By Arrangement, which had further consolidated financial stability. The strengthened exchange rate remained stable, allowing further declines in interest rates, and the external position continued to improve. As a result, inflation had been kept low and the output decline arrested. Broad recovery, however, was delayed owing to continued weakness in domestic demand and a difficult external environment. In this context, the Thai authorities, in March 1999, unveiled a plan to revive domestic demand through additional fiscal stimulus measures. These measures, together with progress in advancing structural reforms, were expected to lead to a resumption of growth in the second half of 1999.

The Asian financial crisis plunged the countries affected into deep recessions. In 1998, real GDP fell by an estimated 6 percent in Korea, by 8 percent in Thailand, and by 15 percent in Indonesia (Table 3). The slowdown in economic activity was greater than had been assumed when formulating the programs in 1997, and accordingly the IMF-supported programs in the three countries were subsequently revised.

The slump in 1998 largely reflected the massive withdrawal of foreign capital and flight of domestic capital; the reversal of capital flows necessitated sizable current account adjustments brought about in part by huge currency depreciations, which in turn worsened the debt profile of corporations. Corresponding to the economic slump were massive corrections in these countries’ external current account balances. The corrections were especially large in Korea (with a current account adjustment of 15 percentage points of GDP) and Thailand (14 percentage points), but also significant in Indonesia (5 percentage points). In all three countries, the output decline was associated with a collapse in domestic demand, whereas net external demand expanded.

Monetary policy in the Asian crisis countries sought to tread a narrow path between preventing a spiral of depreciation and inflation, on the one hand, and avoiding an excessive liquidity squeeze on the domestic economy on the other. These countries did not attempt to pursue fixed targets for the exchange rate, but only leaned against the substantial depreciation that occurred. At the very start of the crisis, these countries’ currencies depreciated sharply (in nominal terms, U.S. dollar per national currency). In Thailand, after an initial 24 percent depreciation during July 1997, a series of smaller (although still substantial) monthly depreciations followed over a prolonged period; these culminated in a 26 percent depreciation from the beginning of December 1997 to mid-January 1998, when the rate bottomed out. In Korea, substantial depreciation was avoided until late October 1997, with the exchange rate then slipping more steeply to its weakest point, in late December 1997. Indonesia’s exchange rate, in contrast, depreciated fairly steadily beginning in July 1997, with the cumulative depreciation reaching more than 80 percent by late January 1998. A limited recovery in the next several months was reversed by large further depreciation in May and June 1998, most of which was recovered by mid- October.

To contain and reverse excessive currency depreciation, interest rates were raised sharply, to peaks of some 32 percent and 25 percent in Korea and Thailand, respectively. Once the currencies began to strengthen, however, rates were reduced. By the summer of 1998, interest rates had fallen to slightly below precrisis levels in Korea and Thailand, and about half of the sharp initial currency depreciation had been reversed. In Indonesia, by contrast, monetary developments were already headed seriously off track in December 1997, reflecting political turbulence and extreme financial system weakness followed by macroeconomic turmoil, with spiraling inflation reaching over 100 percent in the early months of 1998, rising risk premiums, continued capital flight, and a collapse of economic activity. By the later months of 1998, however, the situation had improved markedly, with the rupiah recovering more than half of the depreciation that had occurred at the peak of the crisis.

Table 3Key Economic Indicators: Indonesia, Korea, and Thailand, 1990–991
Real GDP (percent change)
Real total domestic demand
(percent change)
Inflation (CPI)
(percent change)
Government balance
(in percent of GDP)2
Current account
(in percent of GDP)
Total external debt
(in billions of U.S. dollars)
Total external debt, short-term
(in billions of U.S. dollars)
Reserves (in billions of U.S.
dollars; end of period)
Indonesia: gross reserves21.523.8
Korea: usable reserves29.49.148.5
Thailand: gross reserves38.727.029.5

All data are on a calendar-year basis, except as indicated.

General government balance including the interest costs of financial sector restructuring. Cross-country comparisons are not strictly accurate because of differences in definition.

Data are on a fiscal-year basis.

All data are on a calendar-year basis, except as indicated.

General government balance including the interest costs of financial sector restructuring. Cross-country comparisons are not strictly accurate because of differences in definition.

Data are on a fiscal-year basis.

The role envisaged for fiscal policy in the Asian crisis countries shifted with the changing assessment of the economic situation. The initial IMF-supported programs in all three countries included some measure of fiscal adjustment to counter an initial deterioration of fiscal positions—with a view to contributing to current account adjustment and thus avoiding an excessive squeeze on the private sector, as well as building room for noninflationary financing of carrying costs of financial sector restructuring. But beginning in early 1998, with gathering signs of the severity of the economic downturn, fiscal deficits were allowed to expand considerably in all three countries. Fiscal policy expansion to support economic activity went progressively beyond the automatic stabilizers and the automatic effects of exchange rate depreciations.

The Board’s Assessment

The Board discussed the preliminary staff assessment of IMF-supported programs in the Asian crisis countries in December 1998. Directors agreed that the crisis facing the IMF in Indonesia, Korea, and Thailand was quite different from most instances in which the IMF provides financial support. The crisis originated mainly in deep-seated vulnerabilities in the financial and nonbank corporate sectors. Owing to deficiencies in local financial markets, domestic interest rates remained well above international rates, encouraging excessive external borrowing. Investors viewed the long-standing commitments to exchange rate regimes with limited flexibility—which, in some cases, were maintained even when no longer supported by fundamentals—as assurances of exchange value, thereby encouraging excessive foreign exchange exposure. Creditors had also incorrectly assumed implicit government guarantees against default losses on certain types of loans. Owing in part to inadequate banking regulation and prudential rules, borrowed funds were inefficiently intermediated, contributing to overinvestment, unsustainable asset prices, very high exposure to international capital flows, and serious fragilities in the balance sheets of both financial institutions and nonbank corporations.

These elements made these countries highly sensitive to shifts in market sentiment. Some Directors also noted the role of the operations of highly leveraged institutional investors in aggravating this crisis. Directors felt that forestalling crises of this sort would require a more effective monitoring system, better regulation and supervision of domestic financial institutions, and broader efforts to strengthen the international financial system and to set appropriate incentives for pricing risk. More generally, the IMF was examining a number of these issues in the context of its ongoing surveillance activities—and the IMF’s surveillance itself was the subject of an ongoing evaluation by external experts (see Chapter 6).

Comprehensive Approach

Directors agreed that a response to the Asian financial crisis required a comprehensive approach embracing macroeconomic and structural policies as well as external financing. They stressed that structural reforms were an essential part of the overall package, particulary those aimed at addressing financial sector weaknesses and imbalances in corporate finances, improving governance, and strengthening and, in some cases, creating safety nets. Several Directors believed, however, that there may have been scope for a different pacing and sequencing of some of the structural reforms beyond the core financial and corporate sector reforms, or for limiting their number in the first instance, while relegating some to a subsequent poststabilization phase.

The strategy followed in these programs had emphasized restoring confidence through a combination of broad-based policy measures and external financing. Convincing policy packages were essential, as the official funds available fell far short of the countries’ near-term exposure to capital outflows. In light of the potential for short-term capital outflows to continue if efforts to establish confidence were not immediately successful, this strategy involved substantial risk. There was, however, little alternative. Directors cautioned that neither the IMF nor the official community more generally could, or should, try to provide a full guarantee of any country’s short-term external liabilities, nor should they risk any undue substitution of official resources for private financing. A number of Directors felt that larger and more front-loaded packages could have helped restore confidence more quickly and thereby limit the economic impact of the crisis. Most Directors, however, emphasized that the scale of official financing had been unprecedented and that financing should neither substitute for, nor delay, the required policy adjustments.

Central Issues of the Crisis

A central lesson of the Asian financial crisis was the importance of ongoing efforts to devise appropriate ways of involving the private sector in preventing and resolving financial crises (see Chapter 5). Indeed, a few Directors thought smaller official financing packages might have acted as a stimulus to greater private sector involvement. Several Directors thought that earlier action should have been taken in these country cases to “bail in” the private sector.

On the issue of capital controls, a few Directors saw advantages in resorting to them, at least on a temporary basis, and, as a last resort, in particularly difficult circumstances. Most Directors, however, believed that attempts to restrict outflows in the midst of a crisis would almost certainly have hindered the restoration of market access for the country concerned and exacerbated contagion to other countries. Several Directors noted that the Asian crisis underscored the need for appropriate sequencing of the liberalization of capital movements, and saw the need for further work on the appropriate regulatory and prudential regimes.

Directors discussed the factors contributing to the protracted process of restoring confidence. Political uncertainties, and in some instances early hesitations on the part of the authorities in implementing policies in line with the programs, had undermined confidence by casting doubt on the authorities’ commitment to, and ownership of, the programs. In this connection, besides facilitating earlier diagnosis and corrective measures, more complete and continuous provision of financial information would have obviated the need to release disquieting data in the midst of the crisis.

Program Projections

Directors expressed concern over the severe recessions in the Asian crisis countries and observed that the macroeconomic projections on which the initial programs had been based had greatly underestimated the actual economic downturns. This reflected, in part, the fact that the program projections were predicated on the success of the programs themselves. In the event, capital outflows had far exceeded expectations, forcing massive current account adjustment through precipitous depreciations and a sharp decline in domestic demand. At the same time, given the weakness of other economies in the region—most important, Japan—the increase in exports had proved too small to provide sufficient support for economic activity. In Indonesia and Thailand, deteriorating terms of trade had imposed a large and additional negative shock. Some Directors observed that the underestimation of the economic downturn had adversely influenced policy prescriptions, especially with respect to fiscal policy. To better assess the growth outlook in crisis situations, more attention had to be paid in the future to the experience of earlier crisis situations, as well as to regional interlinkages. To this end, Directors saw as desirable more emphasis on regional approaches to surveillance.

Most Directors agreed that in the midst of the crisis, and in the specific circumstances of these countries, it had been appropriate to formulate these countries’ programs on the basis of floating exchange rates. Available reserves had been inadequate to defend a new exchange rate peg. Supporting a pegged exchange rate would have required the full subordination of monetary policy to the exchange rate, which would likely have required substantially higher interest rates than those actually experienced. Moreover, failed attempts to re-peg exchange rates at new levels under crisis conditions would have further eroded credibility.

Monetary Policy

The main goal of monetary policy in the Asian crisis countries had been to avert a depreciation-inflation spiral. In this regard, the programs, after a hesitant start, had been largely successful. Turbulent market conditions required a flexible approach to monetary policy, “leaning against the wind” rather than pursuing a fixed target for the exchange rate. Directors generally endorsed the tightening of monetary policy recommended in the programs in order to arrest and then reverse the excessive depreciation of exchange rates that had occurred. Several Directors pointed out that initially these efforts had been less than successful—owing in part to the hesitant and often uneven monetary policy tightening in the crisis countries—and some Directors argued that the situation had warranted more aggressive and rapid tightening. The eventual degree of monetary restraint was significant but was typical of a crisis situation in which a country’s risk premium is driven up by market forces. Most Directors saw the alternative of keeping interest rates low and allowing the currencies to depreciate as riskier, because the likely result would have been an even worse downward spiral rather than a temporary depreciation.

Although Directors expressed concern over reports of a credit crunch in the three Asian crisis countries—with a few concerned that monetary policies had been too tight—most believed that some strains on borrowers were unavoidable in a situation of excessively leveraged firms and large, unhedged foreign currency exposures. Most Directors saw the primary problem as one of distribution of credit in the economy rather than its aggregate amount, with the main lesson being the need to move ahead forcefully with structural reforms in the financial and corporate sectors and to support viable financial institutions in the midst of a banking crisis. Directors welcomed the fact that interest rates in Korea and Thailand had (as of December 1998) moved back to below precrisis levels, and that market conditions in Indonesia were stabilizing.

Fiscal Policy

Directors viewed fiscal policy as having played a quite different role in the three IMF-supported programs from that originally envisaged. Initially, a limited fiscal adjustment was seen as needed to prevent an excessive burden of external adjustment from falling on the private sector, and to help meet the quasi-fiscal costs of financial sector restructuring. After taking into account the unexpected severity of the recessions and the sharp improvements in current account positions, however, the programs’ original fiscal targets appeared in hindsight to have been tighter than necessary.

Directors welcomed the adaptation of the IMF-supported programs, particularly the easing of fiscal policy in response to unfolding circumstances, although some thought that the easing should have been quicker as the severity of the economic slowdown became increasingly apparent. It was observed that, in practice, the countries had found it difficult to use fully the scope afforded them for more expansionary budgetary policies under the revised programs because of the time needed to develop new social spending programs, as well as the conflict between rapid shifts in fiscal policy and careful management of the quality of government spending.

Structural Reforms

The nature of the crisis and the complementarity of different reforms had necessitated a comprehensive package of structural measures. These reforms were needed, and continued to be needed, to address the root causes of the crisis and lay the groundwork for sustainable medium-term growth. Many Directors felt that the package of structural reforms in each Asian crisis country was essential to restoring confidence on a sustainable basis, but they acknowledged the difficulties in trying to alter market perceptions with policies that were often politically sensitive and that took time to implement and take effect. Several Directors expressed concern that the programs may have been overloaded with reform measures. In their view, better sequencing and prioritization would have involved certain reforms being left to the second stage of the programs. All Directors, however, stressed the need to address, early in the programs, the core areas from which the crisis had arisen—especially the banking and corporate sectors. Given the comprehensiveness of the reforms pursued, success depended critically on cooperation with other international financial institutions, notably the World Bank and the Asian Development Bank. Directors supported ongoing efforts to strengthen such cooperation. Also, noting the difficulties experienced in securing political consensus for reforms, especially when faced with strong vested interests, the Board emphasized the importance of the IMF’s efforts to ensure the authorities’ commitment to, and ownership of, the programs.

Governance and Safety Nets

Reforms in governance, together with the host of issues touching on the establishment of appropriate incentives for private market behavior, were also important, as was the need to ensure that the costs of failure were borne by private investors. Weaknesses in these areas were the underlying cause of many of the vulnerabilities that led to the crisis. Directors thus saw improvements in governance as fundamental to fostering reforms in other areas, including financial and corporate restructuring, competition policy, trade liberalization, and privatization.

The establishment and strengthening of social safety nets to cushion the adverse impact of the crisis on the poor was also an essential element of the programs, and Directors welcomed the ongoing improvements in the targeting of social expenditure and the increased efforts of the World Bank in this domain.

Although there were signs that market conditions were stabilizing and indications that the recessions were bottoming out (as of the December 1998 discussion), Directors cautioned that risks remained. They emphasized that resolute and rapid structural reform was key to consolidating the progress and laying the foundation for sustainable growth.

Summing Up

In summing up the main lessons learned from the experience with IMF-supported programs in Indonesia, Korea, and Thailand, Executive Directors highlighted the following points.

Actions to Forestall Crises

  • Analyze regularly, in the context of IMF surveillance, the continuing appropriateness of exchange rate regimes in light of changing fundamentals.
  • Provide the market continually with accurate, full, and clear financial information, on both public and private sectors, so as to minimize the possibility of negative surprises.
  • Strengthen regulatory and prudential regimes in all countries.
  • Adapt institutions and regulations in creditor countries so as to better ensure an appropriate pricing of risk and to inhibit “bandwagon” behavior.
  • Promote actions to reduce the systemic risk associated with financial market turbulence through, among other things, strengthening disclosure requirements for all investors, including highly leveraged institutions.

Issues Related to Program Design and Implementation

  • Base programs on macroeconomic projections that take full account of the likely regional spillovers associated with a crisis and the effects of a crisis in curtailing countries’ access to private external financing.
  • Undertake further analysis of the particular issues arising in debtor countries from severe banking and financial sector weaknesses in the context of financial crises—including bank closures, government blanket guarantees, moral hazard concerns, and the extent and form of regulatory forbearance in these situations.
  • Encourage the authorities to take decisive actions at the outset to demonstrate adequate ownership of, and public leadership in, the programs.
  • Communicate and explain to markets and the general public, in the closest possible coordination with the authorities, the full content of the program, while avoiding eliciting unrealistic expectations.
  • Exercise flexibility in adapting programs to changing circumstances.
  • Secure early agreement with the authorities and other international financial institutions on a comprehensive strategy of structural reform, particularly as regards financial and corporate restructuring, with due attention to their timeliness and proper sequencing.

Issues Related to Financing of Programs

  • Promote greater involvement of the private sector in forestalling and resolving financial crises.
  • Examine further the issue of the appropriate level of official financing and enhance the credibility of official financing packages, in particular by establishing clear understandings on the conditions for disbursement.

A number of the above points, Directors noted, were being explored further, in particular in the context of discussions of the international financial architecture and of the IMF’s conditionality guidelines.

Russia and Brazil

In contrast to the success of most other transition countries in initially escaping serious involvement in the emerging market turmoil, Russia’s economy fell into crisis in mid-1998. The crisis led to the authorities’ decision on August 17, 1998, to devalue the ruble and unilaterally restructure its domestic government debt. Russia’s economic predicament—worsened by the emerging market crises and their spillover effects, especially on oil and other commodity prices—mainly reflected the serious and persistent shortcomings in its structural reform and institution-building efforts, repeated slippages in fiscal adjustment and reform, and an excessive buildup of short-term government debt, including to foreign investors.

The Russian authorities succeeded in reducing inflation in the period up to August 1998, owing partly to the pegging of the ruble to the U.S. dollar and a relatively tight rein on monetary policy in the preceding two to three years. Inflationary pressures were also suppressed by the accumulation of budgetary arrears, and domestic (nonbank) and external borrowing to finance budget deficits. The underlying fiscal and structural problems were reflected in large-scale capital flight by domestic residents, even when Russia’s economic performance seemed relatively promising. This meant that the increase in external debt was not matched by higher investment and increased export potential.

The government’s incentive to address the underlying problems was further weakened by rapidly falling costs of borrowing in both the domestic treasury bill market and international financial market—a reflection of the strong appetite of foreign investors for Russian securities given exchange rate and interest rate policies. By the time that steps to correct the fiscal imbalances were being implemented in earnest, the reversal in foreign investor sentiment following the Asian crisis and a rapid increase in interest rates had put Russia’s public debt on a steep growth path. With oil and gas export revenues down by about 20 percent in the first seven months of 1998 (compared with the same period in 1997), the external current account balance was also negatively affected and swung into deficit during this period.

On July 20, 1998, the Executive Board approved financial support totaling SDR 8.5 billion ($11.2 billion) for an anticrisis program, which attempted to lengthen the maturity structure of government debt and intensify structural reform. The financing consisted of an augmentation of Russia’s EFF Arrangement by SDR 6.3 billion ($8.3 billion)—of which SDR4.0 billion was to be made available under the Supplemental Reserve Facility—to support the government’s economic program for 1998, and SDR 2.2 billion under the CCFF to compensate for the shortfall in export earnings. The IMF financed the augmentation by borrowing under the General Arrangements to Borrow—the first time the GAB was used by a non-GAB participant.

Measures under the program included a debt exchange (Russian treasury bills swapped for dollar-denominated eurobonds), major fiscal adjustment, actions to address the nonpayment problem and promote private sector development, and a comprehensive approach to banking sector problems. From the time of its introduction, the success of the program depended on whether Russia’s revenue and expenditure measures received full parliamentary approval and whether interest rates were brought down by a return of investor confidence. The failure of these conditions to be realized, and the authorities’ course of action in response—in particular, the unilateral debt restructuring—aggravated the consequences of the program’s breakdown.

Measures under the program included a debt exchange (Russian treasury bills swapped for dollar-denominated eurobonds), major fiscal adjustment, actions to address the nonpayment problem and promote private sector development, and a comprehensive approach to banking sector problems. From the time of its introduction, the success of the program depended on whether Russia’s revenue and expenditure measures received full parliamentary approval and whether interest rates were brought down by a return of investor confidence. The failure of these conditions to be realized, and the authorities’ course of action in response—in particular, the unilateral debt restructuring—aggravated the consequences of the program’s breakdown.

By mid-August 1998, with investor confidence lost, international reserves dwindling, and interest rates soaring, the authorities were unable to defend the ruble exchange rate peg or to refinance maturing public debt. The consequences of the crisis and of the ensuing de facto devaluation, payment moratorium on private sector external obligations, and unilateral restructuring of the government’s domestic currency debt were severely negative. Over the last five months of 1998, consumer prices rose by more than 75 percent, and the ruble depreciated by about 70 percent against the U.S. dollar. Reflecting the severe financial pressure during the run-up to the crisis and the worsening of the overall economic situation in the postcrisis period, in 1998 as a whole real GDP fell by about 5 percent, and real investment declined by close to 10 percent, with foreign direct investment down to $2.5 billion from $6.2 billion in 1997. The budgetary outlook also worsened: revenues raised by the federal government fell to below 10 percent of GDP in 1998, while the federal government deficit amounted to 6 percent of GDP. During the first quarter of 1999, the Russian authorities had yet to come to grips with many unresolved issues. Monetary policy, however, was tightened during January and February 1999 as the central bank did not extend credit to the government and this contributed to a stabilization of the exchange rate and a slowdown in inflation during this period.

For some months, a dialogue continued between the IMF staff and the Russian authorities—with direct contacts between the most senior authorities on both sides—on Russia’s economic problems. As of the end of the financial year, the economy showed signs of recovery from the low point in September 1998 and monthly inflation had decreased—but the debt balance remained unsustainable and, correspondingly, so did the fiscal position. The Interim Committee, at its April 1999 meeting, emphasized that despite recent improvements, vigorous action was needed to tackle the root causes of the Russian crisis—especially persistent fiscal imbalances, structural rigidities, and financial sector weaknesses. Shortly after the Interim Committee meeting in late April, the IMF announced that a tentative understanding had been reached on a new program that could be supported by an IMF Stand-By Arrangement of SDR 3.3 billion ($4.5 billion). It was to be submitted for approval by the Executive Board following the implementation of a number of up-front policy measures, and assuming that agreement would also be reached between Russia and the World Bank on a comprehensive program of structural reform.

Another focal point of the global financial crisis was Brazil, where the first wave of contagion from the emerging market crisis peaked in October 1997. The government responded quickly and was able to stem the outflow of capital by tightening monetary policy and announcing a strong fiscal policy package, promising 2½ percent of GDP in tax increases and spending cuts. Fiscal efforts slipped, however, and financial market concerns about the sustainability of the fiscal position were renewed. As a result, Brazil was hit hard by contagion from the Russian crisis in August 1998 when international investors again reassessed the risk of their exposure to emerging markets. Interest rate spreads jumped and capital flows to emerging markets virtually dried up.

To stem foreign exchange reserve losses of $2.8 billion in August 1998 and $21.5 billion in September, the Brazilian authorities increased official interest rates to nearly 43 percent and announced several fiscal measures. Although the pressure on the real eased, the measures did not offer sufficient relief, and the authorities began discussions with IMF staff on an adjustment program that could receive financial support from the international community.

The subsequent IMF-led international financial package announced in November 1998 resulted in commitments of balance of payment support totaling $41.5 billion, toward which the IMF committed a three-year Stand-By Arrangement equivalent to SDR 13 billion ($18.1 billion). As public sector imbalances were at the root of the problem, the IMF support was linked to a policy package aimed at producing large primary surpluses—on the order of 2½-3 percent of GDP—to halt the rise in the ratio of public debt to GDP by 2000. About two-thirds of the improvement in the government’s finances was to come from revenue measures.

Initially, financial pressures abated, but they increased again in December 1998 when the authorities encountered strong resistance in Congress to the needed social security reforms and also owing to fears that monetary policy was insufficiently tight to stop continued capital outflows. At the beginning of January 1999, when the state of Minas Gerais announced that it sought to renegotiate the payment terms of its debt with the federal government, market confidence in Brazil’s fiscal stabilization plan fell further, with a renewed surge in the interest rate spread. When a number of other Brazilian states joined the request of Minas Gerais, the net capital outflow intensified to $1.2 billion on January 12. This led the authorities, first, to widen the real’s exchange rate band on January 13 and, when this did not stop the financial outflows, to allow the currency to float two days later. The currency initially depreciated by more than 40 percent against the U.S. dollar and remained under pressure until early March.

The key challenge facing Brazil in the wake of the collapse of its exchange rate peg was the need to address public sector imbalances. The Real Plan had succeeded in reducing inflation between 1994 and 1998 but not in containing the fiscal deficit. The fiscal deficit, estimated to have reached 8 percent of GDP in 1998, also contributed to a widening of the external current account deficit, to 4½ percent of GDP in 1998. The combination of these two growing deficits, together with the structure of public debt—which made the government’s finances very sensitive to changes in short-term interest rates and the exchange rate—made Brazil vulnerable to changes in investor sentiment. Ultimately, the twin deficits also contributed to widespread sentiment in financial markets that the crawling peg was not sustainable.

The IMF-supported economic program was revised following the devaluation in mid-January 1999. The two pillars of the revised program were strengthened fiscal adjustment and movement away from the exchange rate as an anchor for the system toward an inflation target. The authorities enhanced the original program’s comprehensive structural reform agenda—in such areas as social security, civil service reform, tax policy, budgetary procedures and fiscal transparency—and were proceeding as well with a substantial privatization program (see also Chapter 7). The government was also committed to cushioning the impact of the decline in economic activity on the poor and vulnerable, by safeguarding well-targeted social programs from budget cuts.

On March 30, 1999, the Executive Board approved completion of the first and second reviews under Brazil’s Stand-By Arrangement, in support of the government’s revised economic program. The approval meant that Brazil could obtain a further SDR 3.6 billion ($4.9 billion), bringing its total borrowings from the IMF under the program to SDR 7.1 billion ($9.6 billion). The authorities were also expected to draw $4.9 billion under a facility arranged by the Bank for International Settlements (BIS) and a loan from the Government of Japan. External financing prospects had improved further as a result of recent or expected disbursements under special programs from the World Bank and the Inter-American Development Bank and of the commitment made by Brazil’s major private bank creditors to maintain their exposure to Brazil.

The April 1999 Interim Committee communiqué expressed support for the Brazilian authorities’ revised economic program and stressed the importance of its full implementation, as well as the continued support of the private financial community.


Published as IMF-Supported Programs in Indonesia, Korea, and Thailand: A Preliminary Assessment, IMF Occasional Paper No. 178, by Timothy Lane and others (Washington, 1999).

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