I’m happy to get away from the United States for a few days and get a break from all the talk of crony capitalism, lack of transparency, collapsing asset values, and large current account deficits. What a difference five years makes! It is the United States that is now going through a time of soul-searching and adjustment, while East Asia appears to be back on track.
But let me turn to our theme today. Is the IMF part of the problem in Asia or part of the solution? The Asian crisis tested the IMF as never before. Many questioned our advice to the crisis countries on the appropriate fiscal policy and monetary policy to follow, and the latter remains a topic of intense debate to this day. Some of the conditions attached to the IMF-supported programs were criticized as being so extensive that they strained countries’ capacity to implement reforms and tested the bounds of the IMF’s expertise. In short, almost every aspect of our core operations came in for scrutiny and criticism.
Roots of the Asian crisis
The Asian crisis was the result of the interaction of several factors. According to some, one factor was the zeal shown by the U.S. Treasury and the IMF in encouraging countries to open up to short-term foreign capital in the mid-1990s and whose subsequent hasty exodus was devastating.
This popular characterization of a greater push toward capital account liberalization is broadly correct but inaccurate in many important details. The IMF did not encourage countries to liberalize short-term flows through the banking sector, which turned out to be the Achilles’ heel during the Asian crisis. And many countries liberalize for their own reasons in response to external prodding. As a result of the criticism received during and after the crisis, however, the IMF is now more vocal in pointing out the risks of rapid capital account liberalization. Six weeks ago, for instance, we advised Sri Lanka against opening up its capital account until its financial sector was further strengthened.
Was the IMF right in Asia?
One feature of our macroeconomic policy advice during the Asian crisis that has drawn a lot of attention is the belt-tightening recommended to Thailand at the start of the crisis. In July 1997, Thailand was still expected to post reasonable growth, had a huge and growing current account deficit, and faced large, though as yet unrecognized, fiscal liabilities in recapitalizing the financial system. It was against this background that the IMF recommended a roughly unchanged fiscal position. However, once the scope of the crisis in Thailand and in the region became evident, we quickly changed course. As a result of our experience during the Asian crisis, our fiscal policy advice is now much more attuned to the need to allow automatic stabilizers to work and to shield vulnerable segments of the population from the effects of the financial crisis.
The more acrimonious debate is the appropriateness of the IMF’s advice on monetary policy during the Asian crisis. The IMF’s position—that a temporary increase in interest rates may be necessary to restore financial stability during a crisis—continues to have its supporters. As [former U.S. Treasury Secretary] Larry Summers noted recently, “when a country’s exchange rate is declining rapidly because capital is trying to leave the country, and the country’s financial institutions are in real trouble, there is a fundamental conflict between restoring external confidence by raising interest rates and providing for financial repair through increased liquidity. It’s a classic problem of a single instrument and multiple targets. Confidence is widely recognized as essential in combating financial crises.”
Others have taken similar positions. [MIT professor] Rudi Dornbusch, for instance, says that “investors will take confidence and bring money back when they see fiscal conservatism and high interest rates. Do that for a few months and you are on the right track.” Our former chief economist Michael Mussa said that those who advocate lowering interest rates at the onset of a financial crisis are smoking something “not entirely legal.”
The debate over this issue has launched a thousand doctoral dissertations. To the extent that there is a professional consensus at the moment, it is that the costs of letting the exchange rate go are much higher than those of a temporary increase in interest rates. The issue is far from settled, but clearly what’s needed is honest debate and a closer look at the empirical evidence, not polemics.
How has the Asian experience influenced the IMF’s view of the conditions [IMF conditionality] attached to the use of IMF funding? Exactly one year ago, the Japanese ministry of finance and the IMF convened a conference in Tokyo that brought together many of the key players during the Asian crisis. Some of the Asian policymakers wondered if all the conditions had been necessary or effective. The Philippine central bank’s Cy Tetangco noted that his country was a “veteran” of negotiations with the IMF. While acknowledging the overall benefits of IMF assistance and conditionality, Tetangco pointed out that the 1998 program had over 100 conditions in 8 areas. Some of these, he said, were critical to helping the Philippines weather the crisis; many others were not or, in any event, could have been better handled by the multilateral developments banks. In Indonesia, Mr. Boediono (currently the country’s finance minister) observed that “perhaps the dismantling of the clove monopoly and the rationalization of the national car and airplane industries could have been postponed until our head was above water.” As a result of these inputs and our own internal assessments, the IMF has been moving to have fewer and less intrusive conditions and to limit them to areas critical to achieving the goals of the IMF-supported program.
We have also been looking into the possibility of disbursing IMF money as certain outcomes are attained. This could help avoid micromanagement by the IMF and address another concern at the Tokyo conference—that IMF programs be flexible enough to allow countries some choice in achieving commonly agreed goals. One participant cited Deng Tsiao-Ping’s advice that it does not matter whether the cat is black or white, as long as it catches mice.
The way the IMF has gone about its current “conditionality review” also illustrates how the IMF has increasingly been carrying out its reforms. We have encouraged open debate by holding conferences in Tokyo and elsewhere and have invited comments through our website. And we have relied, of course, on the wide experience of our own staff, and the judgments of our Executive Board.
Many of the changes I’ve described are of fairly recent vintage, so I do not want to claim that they have transformed the IMF’s way of doing business completely as yet. But I hope they at least convey the sense that the institution is trying very hard to change and trying very hard to be part of the solution to Asia’s challenges.