This year’s International Monetary Fund-World Bank Group annual meetings will take place in Bali, Indonesia, two decades following the Asia financial crisis and in one of the countries that posed great challenges for the IMF at the time.
In this three-part series, I will examine the difficulties faced by the Fund then, how it has evolved, and the trials ahead. My central thesis is that the Fund has transformed itself with considerable success since the late 1990s, particularly in the wake of the 2008 financial crisis. It has demonstrated its relevance to a new generation of global public policy officials, but the Fund will need to stay alert to modernise and cope with new and critical looming challenges. In the end, the need for international monetary co-operation and the IMF remains firmly in place.
The IMF throughout its history has adapted to a changing global landscape to maintain its relevance to the international community. That landscape is replete with financial crises and ‘Minsky moments’, the collapse in asset prices after an extended period of growth, named for renowned US economist Hyman Minsky.
The breakdown of the Bretton Woods system and the Latin American debt crises of the 1980s were emblematic of that reality. The challenges of the 1990s were great, plunging the Fund into uncharted territories. The early 1990s were taken up with addressing the collapse of the Soviet Union and supporting the transition of the ex-Soviet states. The 1994 Tequila crisis, when the Mexican peso suffered a massive devaluation against the dollar, was characterised by some as the first crisis of the 21st century, one in which poor macroeconomic policies were transformed into a virulent capital account catastrophe.
Then came the Asia crisis, following on the heels of the Mexican crisis, but in other fundamental respects throwing up difficulties that, realistically, the Fund had never before faced. The Thailand crisis seemed to be a more classical case of twin deficits, requiring fiscal orthodoxy and monetary restraint. But with Thailand’s woes intertwined with a rigid nominal exchange rate and relatively high interest rates outweighing perceived exchange risks, massive short-term inflows were intermediated through a weak banking system into ‘white elephant’ investments. The ensuing maturity mismatch planted the seeds for rapid outflows and a violent currency crash.
With contagion in the air, Thailand’s weaknesses spread to Indonesia, which at the time did not appear to have bad fundamentals. However, given a rigid exchange rate, massive corruption rooted throughout the structure of the Suharto regime, and once again weak banks and corporate balance sheets, Indonesia could not evade a currency crash that bankrupted banks and corporations. One can criticise the Fund’s handling of certain banking sector restructuring recommendations, but a vacillating monetary policy response in the face of bank runs and a political revolution that precipitated the overthrow of Suharto rendered stabilisation a formidable task.
South Korea’s fundamentals too were strong, but amid contagion, an unclear exchange rate policy, weak corporate governance, connected lending woes inherent to the country’s family-run conglomerates and hidden interbank guarantees, which nearly depleted reserves, a massive loss of confidence and outflow ensued. The collapse in domestic demand was enormous and conditions only began to stabilise with the ‘voluntary’ rollover arrangement put in place at the end of December 1997.
Not only was the rest of Asia impacted, commodity prices were hit, and the crisis spread globally in 1998. These factors, compounded primarily by a weak Boris Yeltsin government incapable of seriously collective revenues, led to a catastrophic Russian default. Brazil could no longer sustain its currency anchor, which had previously broken the back of hyperinflation. Later, the Argentine currency board crashed.
The Fund often rode into the mayhem, with its then traditional mindset of offering a helping hand and willing to play the role of stern taskmaster and allowing countries to treat the IMF as the convenient ‘whipping boy’. Who can forget the iconic photo of IMF Managing Director Michel Camdessus, arms folded, watching President Suharto sign the Fund’s letter of intent.
The Fund’s economic policy prescriptions were hardly perfect, particularly as it was grappling with new challenges – and frankly it is unrealistic to expect foolproof advice in a crisis, any more than one expects an emergency room doctor to save every seriously injured patient. Perhaps there was plenty of blame to spread around. But nonetheless, Asian governments were more than happy to blame the Fund for their woes, and neither accepted nor properly owned up to their publics for the responsibility for their mistakes.
This was unfortunate. The Fund applied tremendous creativity, hard work and diplomacy to helping Asia restore stability. In the end, they did succeed.
Nonetheless, relations between Asia and the Fund were frayed, subjecting the Fund to decades of opprobrium in the region.
As Camdessus’ long and successful tenure at the Fund was ending, its legitimacy in fundamental respects was being challenged due to the Asian and subsequent emerging market crises.
Mark Sobel is US Chairman of OMFIF. This is the first in a series of three articles on the International Monetary Fund since the 1997-98 Asian financial crisis.