The questions raised by the IMF's policies, and now about the severe effects they are having in the region, are very serious indeed, as they relate to the shape of the national economies of East Asia and the very future of the countries.
Fortunately, Malaysia has not been forced by circumstances to seek an IMF rescue package, and thus we have more degrees of freedom to determine short and longer term policies to get out of the crisis.
For those countries already taking IMF loans, it is most difficult (if not almost impossible) to make or modify policies or to change course if things go wrong, as the IMF is always ready to threaten to stop its loans (which are given in small installments) if these countries try to veer even a little from the IMF path.
Malaysia's policy makers have an unenviable task of going through the pros and cons of each policy choice, for each policy option carries both advantages and disadvantages, and thus there are many trade-offs to carefully consider.
4. THE NEED TO REGULATE THE GLOBAL FINANCIAL SYSTEM
The East Asian crisis has shown the threats of volatile and large short-term capital flows to the economic stability of developing countries. What is urgently needed is greater transparency of how the global financial players and markets operate, and reforms at both international and national levels to regulate these speculative flows.
(a) Lack of Transparency
The workings and movements in the international financial markets and system have played the most important part in the East Asian financial crisis. The crisis is also manifesting now in Russia, South Africa and will likely spread to other countries.
It becomes obvious that this global system needs to be monitored and also reformed. Yet there is a great lack of transparency in what constitutes the financial markets, who the major players are, what are their decisions and how money is moved from market to market, and with what effect.
Financial crises cannot be prevented or resolved unless this lack of transparency is removed. That is a first step.
After greater transparency, there is the need to improve the system, to remove its worst aspects and excesses, and to put in place a system in which currency and other financial instruments (shares, bonds, etc) are used for legitimate trade or real- investment purposes and not for non-beneficial speculative gain.
Transparency and reforms are needed in the following areas:
** We need to know who the major institutions and players are in the ownership of financial assets, and their behaviour and operational methods, and the markets they operate in.
How do they gain their leverage? From where do they get their funds and credit and on what terms? How do they operate and through which channels? In particular, how do they view emerging markets and what are their methods to derive maximum profits there?
These institutions include hedge funds, mutual funds, pension funds, investment banks, insurance companies, commercial banks and the finance departments of multinational and big companies.
** What is the system by which central banks of the major Northern countries regulate, deregulate (or decide not to regulate) the behaviour of funds, speculators and investors?
How do central banks coordinate among themselves? Do they (or some of them) coordinate among themselves to influence parameters such as exchange rates and interest rates? What is the role (or lack of role) of the Bank for International Settlements?
** The IMF is the major international financial institution, whose policies can determine the finances and fate of nations. There is lack of transparency on how the staff (who are powerful in the institution) set their policies and conditions, globally and for each nation.
How do the staff determine the policy framework and the specific conditions for loans for each client country? Do they come under the political influence of particular countries (especially the US) and of the major shareholders, and thus lead to a situation where decisions are not made only or mainly on professional grounds?
How do the major shareholders collaborate among themselves? What is the linkage of interests between the IMF secretariat, the US Treasury and other major countries' finance ministries, and the international banks (whose interests they usually serve in getting loans repaid from developing countries)?
There are some studies relating to some of the questions above. However these studies are few. Much more investigation has to be done, so that some basic knowledge of the institutions and system can be gained. On that basis, proposals for changes and reforms can be made.
(b) The Need for Reform
The present system suits the interests of financial owners and speculators. These players have powerful backers in governments or in the U.S. Congress and other Parliaments in the North. Thus getting global reform going is an uphill task.
Nevertheless it is becoming daily more evident that the present system is very unstable and will continue to produce large-scale crises which is becoming too costly for the IMF or the Group of 7 rich countries (G7) to bear. Therefore the question of "a new financial architecture" is being raised by the G-7 themselves.
However the G-7 approach is to try as far as possible to have business as usual. This means not reforming the present system of free and liberal flows of short-term or long-term capital. They do not want regulation at global or national level.
Their approach is to get national governments in developing countries to strengthen their banking systems so that the banks can withstand more shocks that volatile flows will bring in future.
The G7 countries' focus is to have "greater transparency" at national level (so that investors will not foolishly put money in weak spots) and tighter banking regulation so that there will be less chance of a systemic bank collapse.
Such an approach may of course be useful in itself, as no one doubts the importance of strengthening national policies and financial systems.
But surely this "national approach" in developing countries is grossly insufficient and needs to be complemented by a global approach to monitor and regulate cross-border financial flows. At the national level, governments should also be allowed and encouraged to institute regulations to reduce the power of speculative funds (this needs to be done especially in the rich countries) and to reduce the volatile inflows and outflows of short-term capital.
There is a strong case (getting stronger by the day) for greater international and national regulation of financial flows, players and markets, as well as reform of the IMF.
At the global level, there should be a system of monitoring short-term capital flows, tracing the activities of the major players and institutions, so that the sources and movements of speculative capital can be publicly made known.
There can be also be serious pursuit of a global tax on short-term financial flows, such as the well-known Tobin Tax, where a 0.25% tax is imposed on all cross-country currency transactions. This will penalise short-term speculators whilst it will have only a very small effect on genuine traders and long-term investors. The advantage is that not only will speculation be discouraged, but there can be far greater transparency in the markets as movements of capital can be more easily traced.
At the national level, in the Northern countries, which are the major sources of international capital flows and speculation, national regulations can be imposed to reduce the power and leverage of funds.
For example, banking regulations can be introduced to limit the amount and scope of credit to hedge funds. Proposals can be made for this and other similar objectives.
At the national level, in the South, countries should explore options of regulating and discouraging inflows of short-term speculative capital. The well-known case of Chile where 30% of all incoming foreign capital has to be deposited with the Central Bank interest- free for up to one year, can be emulated by other countries.
This device was introduced after an episode of excessive inflows of funds. It has helped to reduce short-term speculative inflows and outflows whilst at the same time it was not a disincentive for the inflow of long-term foreign investment.
Another measure worth emulating is the requirement that local companies seek Central Bank permission before securing foreign- currency loans, and permission should be given only if or to the extent that the project being financed is shown to be able to yield foreign exchange earnings sufficient to service the loan.
This is a requirement established by the Central Bank in Malaysia, and it helped to prevent the country from having the large and excessive short-term foreign-exchange private corporate loans that flooded other countries like Thailand, Indonesia and South Korea.
Further, countries that face a possible danger of sudden and large outflows of funds can consider some limited restrictions (at least for a limited time when the danger is imminent) on the freedom of residents and resident companies to transfer funds abroad.
Such limitations had in the past been in place in countries that now practice financial liberalisation. Indeed restrictions on capital outflows still exist in many developing countries (such as China and India) and have helped to stabilise their financial situation.
Whilst the desirability of regulations on inflows and outflows of short-term capital make eminent sense, countries that have already liberalised and are dependent on the "goodwill" of the financial markets are afraid that reintroducing them could generate a backlash from the market and from the G7 countries.
Thus, it is crucial that the G7 countries themselves review their own anti-regulation position, and give the stamp of approval and legitimacy for developing countries to have these measures. Otherwise countries may not be able to institute measures that are good or necessary for their financial stability and their economic recovery on the fear of being labelled as "financial outcasts."
Once again, the ball is at the feet of the G7 countries to take the lead in both international level and national level reforms.
Meanwhile Malaysia has broken the policy taboo by introducing capital controls and fixing the local exchange rate to the dollar. Many other developing countries are watching closely to see if this enables Malaysia to implement policies that lead to faster recovery. If the Malaysian "experiment" works, this could lead to more countries taking the same path.
5. SOME POLICY LESSONS FROM THE ASIAN CRISIS
Whilst the debate on the causes and processes of the Asian crisis goes on, it is time to draw at least some preliminary policy lessons. Developing countries should rethink the benefits and risks of financial liberalisation. In particular, they have to take great care to limit their external debt (especially short-term debt), improve the balance of payments and build up their foreign reserves.
(a) Need for Great Caution About Financial Liberalisation and Globalisation
One of the great lessons of the Asian crisis is the critical importance for developing countries to properly manage the interface between global developments and national policies, especially in planning a nation's financial system and policy.
In a rapidly globalising world, developing countries face tremendous pressures (coming from developed countries, international agencies and transnational companies) to totally open up their economies.
In some cases and under certain conditions, liberalisation can play and has played a positive role in development. However, the Asian crisis has shown that in other circumstances, liberalisation can wreak havoc, especially on small and dependent economies.
This is especially ture in the field of financial liberalisation, where the lifting of controls over capital flows can lead to such alarming results as a country accumulating a mountain of foreign debts within a few years, the sudden sharp depreciation of its currency, and a stampede of foreign-owned and local-owned funds out of the country in a few months.
Surely then a clear conclusion from the Asian crisis is that it is prudent and necessary for a developing country to have measures that reduce its exposure to the risks of globalisation and thus place limits on its degree of financial liberalisation.
Countries should not open up and deregulate their external finances and foreign exchange operations so rapidly when they are unprepared for the risks and negative consequences. Measures should be adopted to prevent speculative inflows and outflows of funds, and to prevent opportunities for speculation on their currencies.
At the least, the process of opening up to capital flows should be done at a very gradual pace, in line with the growth of knowledge and capacity locally on how to adequately handle the new processes and challenges that come with the different aspects of liberalisation.
This will require policy makers (including in the Central Bank, Finance Ministry, Securities Commission and Planning Unit) to have the proper understanding of the processes at work, the policy instruments to deal with them, adequate regulatory, policy and legal frameworks and the enforcement capability.
Moreover, the private sector players (including banks and other financial institutions, and private corporations) will also have to understand, master and control the processes such as inflows of funds through loans and portfolio investment, the recycling of these to the right sectors and institutions for efficient use, and the handling of risks of changes in foreign currency rates.
The whole process of learning and training and putting the required infrastructure in place will need a long period. Some European countries, which started with already sophisticated financial systems, took more than a decade to prepare for liberalisation, and yet failed to prevent financial failures.
(b) Manage External Debt Well and Avoid Large Debts
At the macro policy level, a very critical lesson from the Asia crisis is that governments have to pay great attention to external debt management.
They have to take great care to limit the extent of their countries' foreign debt. It was the rapid build-up of external debt that more than anything else led to the crisis in Thailand, Indonesia and South Korea, and to a smaller extent, Malaysia.
Developing countries should not build up a large foreign debt (whether public or private debt), even if they have relatively large export earnings.
The East Asian countries are big exporters, including of manufactured goods, and perhaps this led them to the complacent belief that the export earnings would comfortably provide the cover for a rapid build up of external debt. However, a bitter lesson of the crisis is that high current export earnings alone are insufficient to guarantee that debts can be serviced.
For a start, future export growth can slow down (as happened). Then, there can also be a high growth in imports and a large outflow of funds due to repatriation of foreign-owned profits or due to the withdrawal of short-term speculative funds.
In good years these factors can be offset by large inflows of foreign long-term investment. However if the negative factors outweigh the inflows, the balance of payments will register a deficit. Such deficits mean that the country's foreign reserves are being run down.
When a point comes that the reserves are not large enough to adequately pay for the interest and principal of the external debt that is due, the country has reached the brink of default and thus has to declare a state of crisis requiring international assistance.
That flashpoint was reached in 1997 by Thailand, Indonesia and South Korea, necessitating their seeking rescue packages from the International Monetary Fund. Their problems had been compounded greatly by the sharp depreciation of their currencies, thus raising equally sharply the burden of debt servicing in terms of each country's local currency, and making the situation impossible to sustain.
Thus, having a large foreign debt puts a country in a situation of considerable risk, especially when that country has liberalised and its currency is fully convertible and thus subject to speculation.
In particular, having too much short-term debt can be dangerous as it has to be repaid within a short period of months or a year, thus requiring the country to have large enough reserves at that period to be able to service the debts. The structure of debt maturity should also be spread out, keeping in mind the dangers of "bunching," or too much debt coming due at the same time.
It is thus important to watch the relation of levels of debt and debt servicing not only to export earnings but also to the level of foreign reserves. Reserves should be built up to a comfortable level, sufficient to service debt, especially short-term debt.
(c) Manage and Build Up Foreign Reserves
The careful management of foreign reserves has thus emerged as a high-priority policy objective in the wake of the Asian crisis.
Maintaining and increasing foreign reserves is, unfortunately, a most difficult and complex task. There are so many factors involved, such as the movements in merchandise trade (exports and imports), the payment for trade services, the servicing of debt and repatriation of profits, the inflows and outflows of short-term funds, the level of foreign direct investment and the inflows of new foreign loans.
All these items are components of the balance of payments, whose "bottom line" (or overall balance, either as surplus or deficit) determines whether there is an increase or run-down of a country's foreign reserves.
As can be noted, these items are determined by factors such as the trends in merchandise trade, the external debt situation (in terms of loan servicing and new loans), the "confidence factor" (which affects the volatile movements of short-term capital as well as foreign direct investment).
To these must now be added the state of the local currency which in the past could be assumed to be stable but which recently has
become a major independent factor that both influences the other factors and is itself influenced by them.
To guard and build up the foreign reserves, the country has thus to take measures in the short and longer term to strengthen the its balance of payments, in particular the two main aspects, the current account and the capital account.
The first aspect is to ensure the current account (which measures movements of funds related to trade and services) is not running a high deficit.
It was the fear that East Asian countries' wide deficits in recent years were unsustainable that gave cause for speculators to trigger a run on their currencies.
One of the only positive results of the recession is that the current account is now swinging strongly into surplus.
The second aspect is to build up conditions so that the capital account (which measures flows of long and short-term capital not directly related to trade) is also manageable and well behaved.
This can be very tricky, especially in the present volatile circumstances.
On one hand, the country may now need inflows of long-term investment and long-term loans in order to provide liquidity and build reserves. But these must be carefully managed so as not to cause large future outflows on account of problems of profit repatriation and of debt repayment.
And on the other hand, there is the difficult problem of how to manage short-term capital flows. In some past years there were excessive inflows, especially of foreign portfolio investment.
In the past year there has been the reverse problem of large outflows of short-term funds caused by the withdrawal of foreign and local funds to abroad.
It is important that these outflows be reduced so that the overall balance of payments can be in surplus, and the foreign reserves be built up.
Since the flow of these short-term funds are influenced by intangible factors such as "confidence", reducing the net outflows is one of the great challenges of the recovery process.
(d) The Need for Capital Controls and a Global Debt Workout System
The international orthodoxy in recent years of the benefits to developing countries of having a financially open system is now crumbling in light of the extremely high costs being paid by countries that opened up and saw sudden entry and exit of foreign funds.
A new paradigm is emerging that grants that developing countries should have the right to impose capital controls to protect their interests and to enable a degree of stability.
A major lesson of the Asian crisis is that capital controls should not be taboo but be seen as a normal, acceptable and indeed valuable component of the array of policy options avaliable to promote development.
The crisis has also exposed the great lack of an international mechanism that comes to the aid of a country facing severe problems in external debt repayment. A mechanism that includes the declaration of a debt standstill by countries in trouble, with a Chapter 11 type system in which creditors give the affected countries time to restructure their loans and economic activities in an orderly debt workout, is badly needed.
(e) The Market Can Make Big Mistakes and Needs Regulation
Another lesson of the Asian crisis is that the market can make mistakes too, and large or mega mistakes at that.
In recent years, it had become fashionable to think that mistakes are only made by governments, whilst the market knows best.
The debt crises of the 1980s were said to be caused by over- borrowing by the public sector which, being inefficient, had used the loans for unproductive projects, thus plunging their countries into a financial mess.
This led to the conclusion that economic resources and leadership should be passed on to the private sector, which was assumed to be much more efficient since corporations operated on the profit motive.
It was assumed that financial liberalisation and private sector borrowing would not pose problems as banks, investors and companies would have calculated accurately their credit, loan and investment decisions.
There was thus the complacent acceptance of the build up of private sector external debt since it was believed the businesses would make the profits to repay their loans.
The Asian crisis has shattered the myth of the perfectly working market and its efficient use of resources. It shows that markets and the private sector are imperfect, as seen by the huge inflows then sudden outflow of foreign funds, and by the imprudent large external loans taken by the local companies and banks which they are now unable to repay.
When the private sector makes mistakes it can be as costly as (or even more so than) when governments make mistakes. Most top-level companies and many banks in the affected East Asian countries are in trouble or insolvent as a result of having loans and projects gone sour.
Most serious are the loans contracted in foreign currency, for a default in these can bring down the country's financial standing.
In the case of the unrepayable foreign loans in Thailand, Indonesia and South Korea, the "market failure" was caused not only by their local banks and companies. The blame has to be shared by foreign banks and investors that also make the mistake in assessing the credit-worthiness of the loans.
Thus, the financial deregulation measures taken in recent years by governments on the assumption that markets, companies and banks would behave rationally and efficiently, should be reviewed.
There should be a re-balancing of the roles of the state and the markets. At least, the governments have to consider having stronger regulation to prevent private banks, financial institutions and companies from making mistakes, especially in relation to foreign-currency loans.
Malaysian Bank Negara's regulation, that private companies have to seek its permission before taking foreign loans, which will be given only if it can be shown that the projects can earn foreign exchange to finance debt servicing, should be maintained in Malaysia and emulated by other countries.
Indeed, the enforcement of this ruling can be tightened, since many of the companies that obtained permission and borrowed heavily now face difficulties.
(e) Other Issues
The key challenge at present is to adopt the appropriate policy options to steer towards a recovery as soon as possible, whilst recognising the negative and even hostile external environment.
To a significant extent, regional and global developments will continue to provide the backdrop and a critical influence over future developments in the country. For example, if Japan does not recover quickly enough, or China devalues, or the currency crisis spreads to Latin America and Eastern Europe, or if the New York stock market declines suddenly, there will be a significant externally generated negative effect on recovery prospects.
Affected countries can however attempt to take measures that reduce the risks generated from external factors and at the same time improve the domestic conditions for recovery.
In minimising external risks, it would be wise to retain and strengthen the kind of policies and financial regulations that prevented the country from getting more heavily into external debt, such as not allowing companies to borrow foreign-exchange loans unless they can show evidence these will generate the foreign exchange earnings to service the loans.
In a period of increased possibility of reduced external demand, measures should be strengthened to increase domestic linkages in the economy, for example between domestic demand and supply.
There should be increased local production (especially through small and medium sized enterprises) to meet local consumer needs, in all sectors (food, other agriculture, manufacturing and services and inputs in all these sectors). This should be backed up by a sustained "buy local" campaign.
There should be reduced dependence on foreign savings (loans or capital) in order to strengthen the balance of payments and reduce exposure to foreign debt or volatile foreign capital flows.
East Asian countries normally has a very high domestic savings rate. For example, in Malaysia, Gross national savings was 40% of GNP in 1997. The current account was in deficit by 5% of GNP, thus necessitating inflows of foreign funds by that amount in order to maintain balance in the balance of payments.
Since 40% is already one of the highest national savings rates in the world, Malaysia should put its efforts in using the national savings in as efficient and productive a way as possible, and reduce or eliminate the need to augment this with net foreign savings inflow. This would reduce future exposure of the country to foreign loans or short-term and speculative inflows. The same principle can be adopted in other East Asian countries.
On the domestic front, the urgent needs include the resolution of the bad financial situation of private sector companies, and an improvement of the position of the banking system and of banks in relation to non-performing loans. In the process of doing this, fair and proper criteria and procedures should be adopted.
Appropriate fiscal and monetary policies will also be required, balancing the need to revive the economy with the need to have an appropriate exchange rate.
The trade offs involved in choosing a set of policies will require a delicate and difficult balancing act, made even more problematic by the unpredictability of reactions of "market forces" and by external factors such as regional and global developments that are largely beyond the nation's control.
For countries that are under IMF conditions, the difficulty of choosing correct policies becomes much more complicated as the policies are mainly chosen by the IMF, and the governments have to bargain intensely with the IMF for any changes to be made.
Martin Khor
Third World Network
228 Macalister Road
10400 Penang, Malaysia
Tel 60-4-2266159
Fax 60-4-2264505
E-Mail: twn@igc.apc.org