Perhaps we should have seen the Asian crisis coming, but several decades of phenomenal economic growth and strong macroeconomic indicators seem to have duped even the most wary. In 1996, nearly half of the total foreign capital invested in developing countries went to Asia. All indicators pointed toward prosperity, but then unforeseen events triggered the crumbling of the fragile but previously impressive economies. Internal weaknesses that had developed during prosperous times were revealed, and the crisis quickly escalated.

The origins of the current crisis in Asia are traceable to Thailand, although the situation quickly spread to other similarly situated countries in the region. Thailand's double-digit economic growth from 1987 through 1995 attracted substantial foreign capital, largely in the form of short-term loans. Thailand's domestic banks, lacking prudent supervision, invested the money in risky, non-productive assets such as property and equity. Consequently, asset values inflated, and the banks left themselves exposed to substantial foreign exchange risk. In 1995, the strengthening of the U.S. dollar, to which the Thai baht was pegged, resulted in weakened Thai export growth, and increased the current account deficit. The worsening deficit led to speculation about the liquidity of the banks, and to scrutiny of Thailand's financial infrastructure. Having discovered these weaknesses, the panicked investors called their short-term loans. Eventually, and somewhat belatedly, the baht crashed in July 1997 after Thailand reluctantly abandoned the peg to the U.S. dollar.

Virtually the same scenario occurred in Indonesia, except that the corruptness of former President Suharto and his regime exacerbated the lack of overseas confidence. Furthermore, a violent movement against President Suharto, which killed more than 500 people and eventually led to his resignation in May 1998, severely damaged the private and social sectors, and called for emergency action.

In Korea, the ground for the crisis was laid in 1997 when many of the huge conglomerates, or "chaebols," including Hanbo Steel, Jinro and KIA Motors, went bankrupt. The bankruptcies were due in part to over-investment in the automotive and steel industries, resulting in unutilized capacity, as well as to a cyclical downturn in demand. The resulting non-performing loans, which rose to an astounding equivalent of 7.5 percent of gross domestic product (GDP), compounded the existing inadequacies of the financial sector. It did not take long after the Thailand crisis before attention turned to Korea's structural weaknesses, and foreign banks cut off credit.

The lack of confidence in Asia's ability to repay foreign debt led to deeply depreciated domestic currency values that further hindered the public and private sectors' ability to meet foreign debt obligations. After the crisis broke in their countries, Thailand, Korea and Indonesia each sought the financial support of the International Monetary Fund (IMF). As a condition to receiving the IMF's support, Thailand, Korea and Indonesia each had to submit a plan outlining the economic reforms they intended to undertake to address the balance-of-payments problem. The objectives of this article are two-fold. First, the article clarifies the IMF's role in these economic crises, and second, the article highlights the essential elements and objectives of the Asian turnaround plans.

Where Does the IMF Fit In?

Hardly a day goes by that news about the global crisis does not include mention of the IMF. The popular belief, fueled by the well-publicized role of the IMF to come to the financial rescue of the troubled countries of the world, is that the IMF is primarily a world lending institution. In fact, while the lending function is significant, especially in the last two decades, the IMF's original and primary purpose is to encourage international trade, global economic stability and growth by facilitating foreign exchange.

The need for a foreign exchange watchdog became starkly apparent during the Great Depression. A gold shortfall prompted a number of nations, led by Britain, to abandon the gold standard. The resulting uncertainty of the value of money in those nations stifled currency exchange. Between 1929 and 1932, the foreign exchange crisis led to a drop-off of 63 percent in international trade and a decline of 48 percent in worldwide prices.

Today, the IMF has 182 members. The price of membership includes an initial quota,¹ avoidance of foreign exchange restrictions, and the sharing of intentions regarding monetary and fiscal policies. Each member is able to choose its method of exchange value. The IMF monitors its members' actions and status as they pertain to foreign exchange, and the member's ability to make payments on foreign debts. The IMF also provides technical assistance in the areas of public finance and central banking, including assistance with accounting, tax policies and banking regulation and supervision.

While members are required to reveal monetary and fiscal policies, the IMF has no inherent authority over a member's policies. The IMF's real influence over a member's policies, and the reason that the IMF is often in the news, stems from its lending function. The IMF lends to members that are having temporary difficulty in supplying the foreign exchange required by their foreign obligations (often because their own currency value is depressed). The IMF also often spearheads efforts to raise additional funding for troubled economies from the World Bank, bilateral and other sources. In the Asian crisis, the IMF has raised more than $110 billion in support, nearly $40 billion of which came directly from the IMF.

The majority of the IMF funding went to Thailand, Korea, and Indonesia through a Standby Arrangement of almost $4 billion, a $21 billion Supplemental Reserve Facility (SRF),² and more than $11 billion in a combination of Standby Arrangement and Enhanced Fund Facility to each of these countries. Before providing financial assistance, the IMF requires the borrower to submit a realistic plan that must ultimately cure the core problems causing the imbalance of payments, and provide for repayment of the IMF loan.

Fundamental Elements of the Turnaround Plans

The reform plans³ of Thailand, Korea and Indonesia are similar to the extent that their economies all face certain issues: deeply depreciated currency values, financial and corporate sector inadequacies, and the consequences of a recessional environment. Each plan contains the fundamental elements of a turnaround plan, including specific performance measures or quantifiable goals, a detailed and prioritized action plan addressing the underlying causes of distress, and flexibility to adapt to changing circumstances.

Performance Measures. The IMF relies upon macroeconomic measures, including inflation, growth in GDP and the size of the current account, as indicators of the overall success of the reform programs. In each case, the regional recession that continues in 1998 has depressed recovery efforts and resulted in less aggressive macroeconomic goals. Korea and Thailand are currently targeting inflation levels of close to 10 percent for the year. Indonesia, currently expecting 80 percent inflation in 1998, has given itself until 2000 to reach single digit inflation levels. Each economy expects a decline in GDP in 1998. Korea and Thailand plan to contain the decline to 4 and 7 percent, respectively. Both project recovery by 1999. Indonesia anticipates a decline in output of between 10 and 15 percent, but hopes to reverse the decline by 2000.

Emergency Action. The immediate objective of the reform plans is to gain some measure of stabilization in the exchange markets by stemming capital flight. The essential instruments used to achieve the stabilization are a foreign debt strategy and an interest rate policy. The funding provided by the IMF and other outside sources is critical to providing the governments the breathing room needed in order to be able to restructure their foreign obligations. To reverse the dramatic depreciation in currency values, the governments immediately tightened monetary policies. This meant substantially raising interest rates, an unpopular move because it weakens the financial position of the banking and corporate sectors. Raising interest rates helps temporarily restore stability in the exchange rates; to effect a sustainable recovery, however, the reform plans of each country must address the structural problems, first in the financial sector and then in the corporate sector.

Financial Sector Reform. The challenge in the financial sector is not only to restructure the financial institutions, but also to make banking safe, transparent and more efficient. Just a few of the common problems in the banking systems include lack of accounting controls and standards, lack of disclosure, unhedged exposure to foreign exchange and market risk, and lax prudential supervision. Furthermore, relationships between the public, corporate and financial sectors lack transparency and market discipline. To address these issues, each reform plan calls for a conversion to better international practices regarding banking, accounting, auditing and disclosure standards. The IMF and other major financial and professional institutions will provide technical assistance in this regard.

To spearhead the financial sector restructuring effort, each government created autonomous restructuring agencies, including the Financial Supervisory Committee in Korea, the Financial Sector Restructuring Authority in Thailand and the Indonesian Bank Restructuring Agency. These agencies have been empowered to liquidate the most troubled banks and restructure others. The agencies are also proceeding to privatize certain state-owned banks and merge others. To the extent that the recession has impaired the liquidity of viable banks, the governments will issue public debt to fund recapitalization.

Corporate Sector Reform. Closely intertwined with the financial sector restructuring is the restructuring of the corporate sector. Much like the financial sector, the corporate sector restructuring centers on both debt and the underlying problems in the way business has been conducted in the past. In these emerging economies, business practices were largely void of transparency, accounting standards, corporate governance and risk management. The reliable financial information today's investors require was generally not available. In each reform plan, government efforts to revamp disclosure, accounting and auditing to international standards are a priority.

Furthermore, removal of the legal, regulatory and administrative obstacles to voluntary, market-based debt restructuring is high on the agenda. This centers on modernizing bankruptcy laws and procedures in Thailand and Indonesia. (Bankruptcy law in Korea is better established.) The Corporate Debt Restructuring Advisory Committee in Thailand and the Indonesian Debt Restructuring Agency were formed to promote debt workouts by providing a framework for restructuring. In Korea, efforts to restructure the corporate sector center on establishing a forum for voluntary debt restructuring and liberalizing restrictions on foreign ownership. Reform measures in all three countries are moving to eliminate existing disincentives for restructuring, such as restrictions on debt-to-equity conversions and foreign direct investment, as well as negative tax consequences.

Recessional Impact. The reform plans of Thailand, Korea and Indonesia allow for budget deficits in the short term to accommodate increased spending on social and other programs. Increased fiscal spending helps bolster the economy and alleviate the impact of the recession on the poor. This flexibility in fiscal policy has been critical for mitigating the continuing recessional environment and, in Indonesia, the extensive damage caused by the social and political disturbances. Because of the increased spending, as well as the impact of the recession on revenues, Indonesia anticipates a budget deficit of 8.5 percent of GDP in 1998. Thailand and Korea anticipate deficits in 1998 of 2.5 and 4 percent, respectively. To alleviate the budgetary pressure, the governments are implementing privatization programs, restructuring tax systems and generally reviewing fiscal policy and procedures. Indonesia, in particular, plans to achieve a 50 percent decrease in its deficit by 2000, and a balance by 2002.

Progress. For the turnaround plans to have a chance to be successful, they must be implemented by leaders committed to reform. Thailand, Korea and Indonesia have each seen new leaders installed since the outbreak of the crisis. Prime Minister Chuan of Thailand and President Kim Dae-jung of Korea both lead administrations that have exhibited commitment to reform. On the contrary, in Indonesia, significant doubt continues about the ability of Suharto's unpopular successor, President Habibie, to lead the country through difficult reform measures.

Because of the general recession in Asia, it is difficult to isolate the impact of the reform measures taken by these economies thus far. However, we have seen favorable movement in domestic currency values since the reform plans took effect. The Thai baht and South Korean won have significantly rebounded since July 1997 by about 70 and 50 percent, respectively. This has enabled the central banks to reduce interest rates somewhat to ease the pressure on the borrowing sector, although monetary policies generally remain tight. In Indonesia, the political and social disturbances have set back the recovery of the rupiah to less than 30 percent.

Footnotes

¹ Currently, there is about $197 billion in the fund, of which about half is available to members for loans. The U.S. has the single largest quota (approximately 18 percent) and often has veto power over important issues. Return to article

² The IMF recently created the SRF for emergencies arising from capital flight. Korea is the first to benefit from the SRF. Return to article

³ Readers interested in detail can find copies of the reform plans at http://www.imf.org. Return to article