Chapter 18 The East Asian Financial Crisis: A Year Later
- International Monetary Fund
- Published Date:
- January 2001
One year after the crisis erupted in Thailand and spread to other countries in the region, East Asia is littered with idle plants, insolvent financial institutions, loan defaults, and bankrupt businesses, both large and small. All of the countries hit by the currency attack are now in deep recession. GDP growth in these countries will collapse in 1998 with no prospects for early recovery. The total volume of foreign capital inflows into these countries has dwindled to a trickle and will not likely exceed the level of 1997. Similarly the real exchange rates, which depreciated sharply in 1997, are not likely to change significantly for some time to come. The stock markets in the region remain depressed and show little sign of recovery.
Thailand, Indonesia, and Korea are expected to generate large “recession surpluses” on their current accounts, ranging from two percent of GDP in Indonesia to eight percent in Korea in 1998. It was expected that after the IMF programs were initiated the patterns of adjustment in these countries would follow a “V” shaped recovery, but with the passage of time, it appears that the performances are more likely to resemble the letter “L” with long drawn-out floors. Unlike Mexico in 1994 and 1995, the East Asian countries are going to suffer a deep, sharp shock with long-lasting effects. The East Asian recovery has been further frustrated by the ongoing recession and financial crisis in Japan, which is no longer able to play the role of locomotive in the region.
Thailand, Indonesia, and Korea have been implementing IMF rescue and restructuring plans. In all three countries, the major components of the IMF programs include: a macroeconomic policy framework based on fiscal tightening and monetary contraction aimed at stabilizing the nominal exchange rate; financial, corporate, and labor market restructuring; and market deregulation and opening, including the financial sector.
Although still ongoing, it is fair to ask whether these policies have been effective. The IMF programs were designed to reestablish financial market confidence by stabilizing the exchange rate. In this regard, the contractionary monetary and fiscal policy was necessary and to some extent successful in calming the foreign exchange markets in earlier stages of the crises, but it has also exacted a heavy cost, as we shall discuss later in this section. The IMF places emphasis on structural reforms as a crucial element of its rescue programs in restoring financial market confidence. To signal their determination, the crisis countries were asked to take decisive actions by closing or suspending nonviable financial institutions and following a strict time table of longer-term reforms for the financial markets, corporate governance system, and domestic market liberalization and opening.
In earlier stages of the crisis, the IMF program for Korea stood out as the most successful of all the similar programs applied to countries in East Asia. A wide range of measures for financial market opening, suspension of a number of failing merchant banks, and most importantly, the Korean government’s commitment to restructuring of financial institutions saddled with huge burdens of nonperforming loans and high-leveraged and poorly managed large conglomerates were well received and widely considered appropriate by foreign financial market participants and multilateral institutions alike. This favorable response no doubt helped Korea to reschedule $24 billion in short-term foreign liabilities at banks into longer-term loans in early February 1998.
This rescheduling was followed by the successful floating of $4 billion in sovereign bonds in April 1998. These two events were regarded as the turning point in Korea’s adjustment in the crisis and signs of a quick recovery, resembling the pattern of the Mexican adjustment. However, the Korean economy has since sunk deeper into recession, and perhaps for this reason, foreign creditors’ confidence has yet to be restored, as evidenced by Korea’s borrowing cost premium of 500 basis points or more over LIBOR.
Soon after the restructuring plan was announced in Korea in early 1998, reports began to surface that the levels of nonperforming loans and corporate debts were much higher than expected. The total of nonperforming loans at banks was estimated to be more than 100 trillion won ($70 billion), much more than expected, and the volume of corporate debts was estimated at almost twice the size of Korea’s annual GDP. The dismal state of affairs at Korean corporations and financial institutions naturally raised uncertainties in the minds of foreign creditors as to whether Korea would be able to mobilize enough resources domestically to pay off these debts.
In the meantime, high nominal interest rates and a credit crunch further deepened the recession. Since most Korean firms are highly leveraged, the high cost of credit increased their debt service burden so greatly that a growing number of both large and small firms—some of which would be completely viable under normal circumstances—have been closing down their operations. The unemployment rate at the beginning of May 1998 was more than twice that of a year earlier, and the GDP growth forecast for 1998 has been revised downward yet again to -5 percent. The current account has been generating a huge surplus almost entirely because of the collapse in imports.
Contrary to initial expectations, the real exchange rate depreciation and domestic recession have not improved the prospects for a boom in Korea’s exports. Exporters have been hampered by the limited availability of supplier credit and by the unwillingness of foreign banks to accept Korean banks’ letters of credit. The limited availability of import credits has also made it costly for exporters to import parts, components, and other industrial materials needed to produce export goods.
What has gone wrong in Korea and the other crisis countries in East Asia following an IMF program? By and large Korea’s experience with restructuring typifies the kinds of predicaments these countries are facing, although they would, of course, differ in detail.
Foreign lenders including major international banks have yet to resume new lending. They are even reluctant to restore trade credit facilities, largely because they are uncertain about the outcomes of the restructuring plans of these countries. Their position has been that they would not return to East Asian financial markets unless they are convinced of the success of the restructuring efforts mounted by these countries or at least until they see some positive signs that the restructuring program is working. The IMF has been monitoring the process of restructuring in these countries and has on many occasions expressed its satisfaction with the progress they have made. The IMF’s endorsement, however, seems to have done little in the way of building up foreign creditors’ confidence in these countries. Perhaps, as Radelet and Sachs (1998b) point out, the IMF may be “poorly placed to rally market confidence in the short run.” Given the intense criticism directed at IMF programs, the majority of foreign lenders may have little confidence that the IMF programs are really the best for the crisis countries in East Asia.
More importantly, there is no consensus on what constitutes a successful restructuring, that is, the scope, speed, and an optimal path of adjustment, a successful reform of banks, corporations and labor markets would require. There are also no widely accepted indicators or criteria by which one could judge whether a restructuring program is progressing as planned. Foreign market participants cannot be lumped into a single group of homogeneous lenders. Instead, they include a large number of commercial and investment banks, insurance companies, bond market dealers, and fund managers of all types with diverse business backgrounds, and different investment strategies and interests. It is hard to imagine that as a group they could reach a consensus on a restructuring program which they believe help these East Asian countries to find a way out of the current crisis. Different individual lenders are likely to have different views on the appropriate scope and speed of any restructuring plan and to react differently to the side effects of a crisis. Some creditors may not believe these crisis countries would survive or have the will to follow the restructuring plan through the end. In some quarters of creditors, the side effects may be viewed as the sign of a mismanaged and hence unsuccessful restructuring. In particular, small lenders have been sensitive to the market disruption and instability that inevitably occur during the restructuring process.
Moreover, the dilemma of the collective action problem that played a role in causing the crisis also serves as a serious roadblock to the restructuring process. Individually, some foreign creditors probably believe that the IMF program is the best alternative for the crisis countries to restore market confidence in East Asia. They may also realize that restructuring is a protracted process often marked by backslidings and relapses and often detracted by the adversely affected groups such as labor unions. They also likely know that the resumption of lending and the restoration of export and import related credits is crucial for speeding up the restructuring process. However, few individual creditors will make a move if other creditors do not lend as well.
The reluctance of foreign creditors to restore trade credit facilities and to extend new loans to these countries creates a serious dilemma of a non-cooperative game. Their reluctance to normalize the credit flows into these countries certainly hampers and possibly jeopardizes the entire restructuring program. In fact, the longer creditors wait until they see tangible results of restructuring, the less likely they are to see the results they want to. The reason for this is that the restructuring plan cannot be engineered successfully unless corporations and banks are able to obtain trade credits and new loans from international financial markets. International creditors know this, but they demand the evidence that the restructuring plan is moving in the right direction before extending their loans. And different lenders demand different pieces of evidence. As a result, the catch 22 situation continues in East Asia.
Individual lenders also know the pitfalls of the non-cooperative game that both they and East Asian countries are locked in. However, individual lenders would not take an initiative by making new loans unless other lenders are prepared to do the same. As in the case of a self-fulfilling crisis, the problem of collective action in international capital markets could possibly derail the IMF guided restructuring plans.