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IIF Press Briefing: New Approaches Are Needed to Address Weaknesses of Global Financial System

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 1999
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“The financial crises of the 1990s differ from those of the 1980s and require a 1990s approach.” With these words, William Cline, Chief Economist and Deputy Managing Director of the Institute of International Finance (IIF) announced the publication of Financial Crises in Emerging Markets—prepared by an IIF working group, which he chaired. In a press briefing held on January 22, Cline, along with Charles Dallara, the institute’s managing director, discussed the IIF’s recommendations for reforming the global financial system, adding that all the major players—including the seven major industrial countries, the Group of 22 industrial and developing countries, and the IMF—agreed with this objective.

“It is time,” said Dallara, “to look at the weaknesses as well as the strengths” of the global financial system “and to address the weaknesses” so as to prevent future crises.

Crisis Periods Compared

Unlike the debt problem of the 1980s—which was perceived to be largely one of liquidity (short term) but was eventually recognized as one of solvency (longer term)—the problem of the 1990s was more compellingly one of liquidity, the report states. The ratio of debt service due to exports of goods and services averaged 83 percent for Argentina, Brazil, and Mexico in 1982, but only 22 percent for Mexico in 1994 and for Indonesia, Korea, and Thailand in 1996. Another difference between the two crisis periods, according to the report, is that sovereign debt dominated the 1980s, whereas private corporations and banks were responsible for a greater share of obligations in the 1990s (see table, page 64). Similarly, the bulk of claims in the late 1980s took the form of long-term bank loans, whereas by the late 1990s the composition of claims had shifted to short-term bank loans, bonds, and local currency obligations. Furthermore, today’s capital markets involve more diverse sources of finance, which can hasten the return of flows to the markets as confidence rebuilds.

IIF Recommendations

The hallmark of the 1990s approach to crisis resolution, as outlined in the IIF report, is the prompt restoration of private sector confidence through large—but temporary—public sector support of countries’ domestic policy adjustment and a greater reliance on voluntary market response. In contrast, the approach of the early 1980s emphasized formal debt rescheduling and, eventually, debt reduction by private banks. It ultimately became clear that full-fledged debt rescheduling tended to choke off voluntary new lending for some time. It took almost a decade after the 1980s crisis, says the IIF report, for capital flows to emerging markets to revive.

Cline described a number of other innovations of the 1990s approach. Fundamental, he said, is a dialogue between private international creditors and investors and the authorities of borrowing countries. Such a dialogue can enhance the stability of the system by ensuring that the authorities are made aware of growing private sector concerns and can institute policy reforms early to avoid a crisis. The IIF strategy would place country authorities rather than IMF officials—as in current practice— at the center of the dialogue with the private sector. The issue, Cline said, is greater transparency, which would reveal problems at an earlier stage—thus avoiding “rude surprises”—and make it possible to minimize major market disruptions. The report outlines a number of ways to lure the private sector to participate voluntarily in crisis resolution efforts. One reason for the new approach is the concern that a protracted financial crisis and disruption of debt servicing could impose a severe shock on emerging capital markets globally.

The IIF report notes that the 1990s approach has been criticized for calling for large amounts of official support, which detractors say will increase moral hazard in international lending by giving private sector creditors the impression that they can lend without risk. It concludes, however, that the benefits resulting from the restoration of private sector confidence engendered by official support outweigh the possible distortions from moral hazard.

The IIF report also discusses the IMF’s lead role in international surveillance, but describes the IMF’s influence as weak in countries that do not have a program of financial support. It reiterates, however, an earlier IIF finding that IMF programs were not outdated recipes for austerity that were inappropriate for the East Asian situations, as some critics have charged. The report also calls for countries to be allowed to publish their IMF Article IV reviews without Executive Board approval and opposes IMF lending to countries with arrears to private creditors, which it says can undermine the confidence of the private sector.

Composition of External Debt for Major Emerging Market Economies
19881997
Total (billion dollars)944.71,882.7
(percent)
By creditor1100.0100.0
International financial institutions14.712.6
Official bilateral creditors27.521.2
Commercial banks45.334.3
Other private creditors12.531.9
By borrower2100.0100.0
Public sector75.549.5
Deposit money banks11.223.7
Other private sector13.226.8

For 29 emerging market economies.

For 18 emerging market economies with total debt of approximately $1.4 trillion in 1997. Includes some estimates for 1996 or 1995.

Data: Institute of International Finance, 1998, Report of the Working Group on Financial Crises in Emerging Markets (Washington).

For 29 emerging market economies.

For 18 emerging market economies with total debt of approximately $1.4 trillion in 1997. Includes some estimates for 1996 or 1995.

Data: Institute of International Finance, 1998, Report of the Working Group on Financial Crises in Emerging Markets (Washington).

Conclusion

The IIF report lists six major examples of what can now be seen as the 1990s approach to resolving financial crises: Mexico in 1995; Indonesia, Korea, and Thailand in the second half of 1997; Russia in July 1998; and Brazil in December 1998. In all six episodes, it observes that the countries involved instituted forceful economic adjustment programs, with the common goal of creating the necessary conditions for restoring private sector confidence and renewing the inflow of private capital. Mexico, Korea, and Thailand are success stories, whereas Indonesia and Russia represent defeats, attributable to the absence of the domestic political conditions necessary for prompt implementation of adjustment measures. The jury, Cline said, is still out on Brazil.

Within the working group, the view dominated that the existing institutional arrangements, especially with the recent IMF quota increase, should be adequate to deal with and minimize crises, as long as private market participants, national authorities, and international official agencies adopt more astute behaviors and policies in light of the lessons from the recent crises.

Photo Credits: Denio Zara, Padraic Hughes, and Pedro Marquez for the IMF, pages 49-53, 55, and 57; Reuters, page 58.

Copies of the working group report Financial Crises in Emerging Markets are available for $25.00 each from the Institute of International Finance, 2000 Pennsylvania Ave., NW, Washington, DC 20006. Call (202) 857-3616.

Ian S. McDonald

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Sara Kane

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Philip Torsani Art Editor Victor Barcelona

Graphic Artist

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