A central part of the programs in the Asian crisis countries was an unprecedented body of structural reforms ranging from restructuring insolvent financial institutions, to promoting competition in the domestic economy, to strengthening social safety nets, to addressing deficiencies in governance in financial, corporate, and government sectors. These measures were intended to address structural problems that had contributed to the crisis and to provide the foundation for a return to sustainable growth.

A central part of the programs in the Asian crisis countries was an unprecedented body of structural reforms ranging from restructuring insolvent financial institutions, to promoting competition in the domestic economy, to strengthening social safety nets, to addressing deficiencies in governance in financial, corporate, and government sectors. These measures were intended to address structural problems that had contributed to the crisis and to provide the foundation for a return to sustainable growth.

The World Bank and the Asian Development Bank played essential roles in developing the structural components of the programs (Box 8.1). In some instances, the initial programs mapped out areas in which more detailed plans were to be developed with the assistance of these international and regional multilateral financial organizations over the ensuing months. In Korea, for instance, these areas included corporate governance and restructuring and labor market reforms.

This section characterizes and assesses the strategy of structural reforms in these countries. It first discusses financial sector reform and corporate debt restructuring. Given the repercussions of the problems that had surfaced in these sectors, these reforms were particularly critical. The strategy pursued included both measures to handle the crisis and its aftermath and reforms to minimize the likelihood of recurrence. It inevitably evolved with events and with a deepening understanding of the problems. Some key lessons that emerge are a need to elaborate the IMF's policies in the area of financial crisis management (including the coverage of government guarantees) as well as financial and corporate Restructuring; the need to treat corporate restructuring as part and parcel of financial sector restructuring; and the need to give early priority to addressing deficiencies in the institutional and legal framework for financial and corporate sector restructuring.

Reforms to enhance governance and competition, which were seen as complementing the restructuring of the financial and corporate sectors, are addressed next. This is followed by a discussion of measures to further current and capital account liberalization, which sought to prevent a lapse into beggar-my-neighbor restrictions, support competition in domestic markets, and remove the distortions that had resulted from previous partial liberalizations.

Concerns about the impact of the crisis on the poorest and most vulnerable segments of society were expressed from the outset and became increasingly pressing as the domestic recession deepened. Social sector policies are reviewed, including measures to limit unemployment, raise income transfers, and broaden social safety nets, which were regarded as an integral part of the programs.

The concluding section addresses the question of whether the structural reform agenda of the programs was too ambitious. While this question cannot entirely be dismissed—and indeed points to a need for further consideration of the appropriate pace and sequencing of reforms—the urgency of the crisis and complementarities among different reforms called for many steps to be taken simultaneously. Moreover, the programs may be viewed as providing a framework for reforms over a three-year period, including aspects to be dealt with—and spelled out in more detail—by the World Bank and the Asian Development Bank.

Financial Sector and Corporate Restructuring

Given the central role that financial sector vulnerabilities had played in bringing about the crisis, financial sector restructuring stood at the top of the structural reform agenda and formed the centerpiece of all three programs. While many previous IMF-supported programs have included measures to restructure and reform financial systems, the programs in the Asian crisis countries were unparalleled in the scope of issues that had to be dealt with under severe time constraints. There were, of course, many precedents of financial sector crises and restructuring from which to take cues, and expert knowledge was made available through extensive technical assistance from the IMF, the World Bank, and the Asian Development Bank. There was, however, no generally accepted roadmap—the structural equivalent of a financial programming framework—to guide the formulation of the structural content of the programs from the outset. Moreover, since the programs did not anticipate the magnitude of the exchange rate depreciation and the severity of the recession (as discussed in Sections IV and V above), they likewise did not anticipate the full extent of the financial system problems that would result. In these circumstances, the strategy for financial and corporate sector restructuring was, inevitably, reactive. It evolved as initial measures proved inadequate, new information about the problems in financial institutions and corporations became available, and the difficulties themselves were aggravated by the currency depreciations and the sharp contraction of economic activity.

The World Bank and the Asian Crisis

The World Bank Group has been heavily involved in each of the three crisis countries, providing policy and technical advice, as well as financial support.

In Korea, the World Bank has disbursed a $3 billion Economic Reconstruction Loan (December 23, 1997) and a $2 billion Structural Adjustment Loan (March 26, 1998), in addition to technical assistance loans, and lending from the International Finance Corporation; a second, two-tranche Structural Adjustment Loan for $2 billion is planned for 1998/99. For Thailand, where the World Bank pledged $1.5 billion at the Tokyo meeting in August 1997, the Bank's Board approved a $15 million Financial Sector Implementation Assistance Loan (September 11, 1997) and a $350 million Finance Companies Restructuring Loan (December 23, 1997). A further Economic and Financial Adjustment Loan for $400 million, and a Social Investment Project, for $300 million, were approved in July 1998. In Indonesia, disbursements amounted to $899 million in 1997; in 1998, $600 million of the $1 billion Policy Reform Support Loan (approved on July 2, 1998) was disbursed, in addition to about $600 million of project-related loans.

Key areas of World Bank involvement include reform and restructuring of the financial and corporate sectors, as well as strengthening of the social safety net and reform of the labor market.

In the financial sector, the World Bank (in collaboration with the IMF) played an especially important role in

  • Formulating and implementing the strategy for dealing with commercial banks, finance companies, and specialized financial institutions (see below).

  • Assessing the solvency of the banking system and the standing of the main (systemically important) institutions, based on bank audits. The World Bank also contributed to developing plans for dealing with insolvent institutions, for disposing the assets of closed banks, and for handling the nonperforming assets of banks that were to be publicly supported.

  • Improving the overall financial infrastructure, including measures to strengthen banking supervision and the redesign and reinforcement of prudential regulations in accordance with the Basle standards.

  • Providing expertise on instituting (or strengthening) deposit insurance schemes.

  • Updating banking laws to include provisions that had been lacking (for example, on limitations of cross ownerships between banks and enterprises).

  • Strengthening the development of money markets and capital markets through the encouragement of new institutional investors (such as mutual funds), asset securitization, standardization of government bond issues, and improvement of securities market prudential rules and self-regulatory organizations (SROs).

In the corporate sector, the World Bank has provided technical and financial assistance for corporate restructuring (and debt restructuring) and improved corporate governance.

  • In Thailand, the Finance Companies Restructuring Loan helped conduct in-depth assessments of the (nonsuspended) finance companies and their rehabilitation. The loan also helped strengthen prudential regulation and the supervisory regime.

  • In Indonesia, the World Bank supported the September 1998 Jakarta Initiative's voluntary frame-work aimed at encouraging debtors and creditors to negotiate solutions to their debt problems on a caseby-case basis.

  • In Korea, the Structural Adjustment and Economic Reconstruction Loans supported improvements in the responsibilities, independence, and accountability of corporate boards, and enhancement of minority share-holder and institutional investor rights; improvement in the reliability of key financial information provided by banks and corporations to regulators, shareholders, and the public; adoption by financial institutions and corporations of accounting, auditing, and reporting standards consistent with international best practices; enhancement of competition through strengthening of the Fair Trade Act; and facilitation of the liquidation of insolvent corporations.

The World Bank's efforts to improve social safety nets and reform labor markets include the following:

  • In Thailand, a Social Investment Project intended to fund job creation through existing labor-intensive government programs; expand training for the unemployed; support low-income health insurance schemes; support small- and medium-scale community and municipal projects; and establish a monitoring system to evaluate the impact of the crisis.

  • In Indonesia, expanded labor-intensive public works programs; actions to ensure provision of moderately priced essential goods; and initiatives to maintain access to basic education and health.

  • In Korea, measures to increase labor market flexibility (such as elimination of restrictions on man-power leasing and strengthening employment services) while extending unemployment insurance coverage to employees of small-scale enterprises; improved poverty monitoring and protection of poverty-related public expenditures; adjustments to health insurance to improve protection of poor beneficiaries and improvements in administration; and reform of the pension system.

Source: World Bank.

While the details of the reform agenda had to be worked out as the programs evolved, there was, from the outset, a consensus that the strategy had to include two broad strands: the immediate crisis, triggered by serious weaknesses in the balance sheets of financial institutions, had to be dealt with; and the systems had to be reformed to minimize the likelihood of a recurrence. Institutions that were evidently insolvent needed to be cleaned up or closed down, and a comprehensive examination of other institutions was required to assess and, if necessary, strengthen their balance sheets. These measures needed to be accompanied by steps to address the twin risks of bank runs and uncontrolled liquidity expansion. Such crisis management had to go hand in hand with credible steps to address the underlying structural weaknesses of the financial system: inadequate prudential regulation and supervision, and the legacy of a long history of direct government intervention in the allocation of credit, which had left financial institutions ill equipped to assess, price, and manage risk in an increasingly open environment. Both strands of the strategy were essential for either to succeed: strengthening weak institutions to continue business as usual in a poorly regulated system would have given at best temporary relief; by the same token, there would have been little benefit to setting adequate rules for institutions that remained in or close to insolvency.

Actions to suspend or close a number of clearly insolvent institutions were taken at (or prior to) the beginning of the programs in all three countries. While these steps were taken early to arrest further deterio-ration and signal the governments' resolve, they proved to be only a prelude to a long and arduous process that is still evolving. In Thailand, four months passed until a decision on the ultimate fate of the suspended finance companies was taken,1 and a more comprehensive strategy to assess, recapitalize, and, if necessary, intervene in a broader range of financial institutions emerged only gradually in the course of the following year. In the process, a number of banks that had initially been viewed as sound turned out to be in difficulties and required intervention. In Korea, the merchant banks that were suspended at the beginning of the program were dealt with quite promptly,2 but further interventions became necessary as the recapitalization and restructuring program was broadened to other financial institutions. In Indonesia, 16 banks, accounting for less than 3 percent of the banking sector's total deposits, were closed initially; financial sector conditions deteriorated rapidly after the initial steps amid severe political unrest and a large number of banks were intervened before a comprehensive restructuring and recapitalization plan was finally launched nearly one year after the start of the original program.3

All three programs emphasized the role of private funds, domestic as well as foreign, in the recapitalization and restructuring of financial institutions, but it was recognized from the outset that public money would also need to be made available, notably in connection with the resolution of suspended or closed institutions and the recapitalization of fully or partly state-owned banks. The approach that was typically followed was to request financial institutions to develop rehabilitation plans that would enable them to meet, within a specified time frame, more stringent norms regarding capital adequacy, loan classification, and provisioning. The authorities would intervene in those institutions that did not produce acceptable plans.4

As macroeconomic conditions deteriorated and difficulties in the financial sector spread, it became increasingly clear that the initial resolve to rely mainly on private schemes for recapitalization and restructuring was unrealistic and public funds assumed growing importance. This raised concerns about the conditionality of such funding, particularly in Korea where public funds had played a significant role from the outset,5 and prompted efforts to define more precisely the conditions under which public money would be made available, including the nature and extent of the required private contributions. As a result of the growing reliance on public funds, the government's stake in the financial sector increased significantly in the three countries, although the programs contain clear commitments regarding early reprivatization.

While the recapitalization and restructuring of a large part of the financial system is inevitably a lengthy process, shortcomings in the institutional and legal framework in the crisis countries helped to prolong it. In both Indonesia and Thailand, it took several months to establish agencies to oversee and manage the restructuring process, and more than half a year passed until procedural and legal aspects of their operations were clarified.6 In addition, laws and regulations concerning write-downs of share-holder capital, collateral protection, privatization of state banks, and foreign ownership of financial institutions had to be reviewed and modified. The original programs generally recognized the need for action in these areas, but many specific measures were developed only as the programs evolved, and implementation of the necessary changes took considerable time, particularly in Indonesia and Thailand.7 In retrospect, these legal and institutional changes should have been given higher priority in the early phase of the programs as they were a precondition for restructuring to proceed.

Prior to the crisis, only Korea had a formal deposit insurance system, but the general perception in all three countries was that a large part of the deposit base was covered by implicit government guarantees. This perception changed when the crisis broke. Faced with the possibility of widespread bank runs, both Korea and Thailand announced broad-based guarantees to calm depositors. The programs accepted this approach, but sought to minimize the risk of moral hazard by stressing the need for a strict time limit (and replacement by a funded and more limited deposit insurance system) as well as accompanying measures such as guarantee fees and caps on deposit rates.8 Indonesia initially followed a different route and promised compensation only to small depositors of the banks that were closed at the beginning of the program.9 In addition to the limited coverage for deposits in private banks, the guarantee was not widely publicized, and no announcement was made regarding the treatment of depositors in other institutions that had not yet been intervened. After several waves of deposit runs, a comprehensive guarantee scheme covering all bank depositors and creditors for a period of two years was introduced in January 1998.

While bank runs were particularly severe in Indonesia, they also occurred in the initial phases of the programs in Korea and Thailand. In response, central banks stepped up liquidity support for the affected institutions. In principle, this support was to be short term and subject to conditions. In practice, notably in Indonesia and Thailand, the funds were repeatedly rolled over and intervention of the institutions that relied heavily on this financing eventually became necessary. Conditionality was typically limited to punitive interest rates, which were, however, not much of a deterrent for institutions that were already insolvent, especially as in many instances the interest was capitalized. Moreover, in Korea, the interest spreads charged on the central bank's foreign currency support for banks soon lagged behind soaring market spreads and had to be adjusted significantly to discourage extensive use of the facility. While in Korea and Thailand, liquidity support by the central bank10 was relatively quickly sterilized and brought under control, in Indonesia it helped to derail the monetary program and eventually necessitated a fundamental overhaul of Bank Indonesia's liquidity facilities.11

The programs recognized from the outset that fundamental improvements in the regulatory and supervisory framework in the crisis countries would be required to ensure that financial institutions would start operating on a sound basis. Without such measures to address the “flow problem,” efforts to deal with weak balance sheets (the “stock problem”) would at best enjoy temporary success. In the initial phase, the programs typically focused on incremental improvements in loan classification and provisioning standards, capital adequacy requirements, and foreign exchange exposure limits. In view of the precarious situation of many financial institutions, a degree of regulatory forbearance was generally accepted and more stringent requirements were typically introduced in a graduated fashion. However, the tightening of loan classification standards frequently lagged behind the tightening of capital adequacy requirements, rendering the latter less meaningful.

Comprehensive revisions of prudential regulations are under way in all three countries. The ultimate objective of these reforms is to bring regulatory standards in line with Basle Core Principles and, particularly in Korea, to expand their coverage to institutions that were previously not subject to these requirements.12 In addition to loan classification and capital adequacy standards, the planned revisions cover restrictions on foreign exchange and liquidity exposure as well as rules regarding lending to connected parties. Steps have also been taken to improve accounting standards and tighten disclosure requirements for financial institutions.

As the process of financial sector restructuring advanced, the importance of complementary measures to address weaknesses in the corporate sector became increasingly evident. In Korea and Indonesia, deficiencies in corporate governance were recognized at the outset, but were not given high priority.13 In Korea's initial program, corporate governance and restructuring was one of the areas in which the World Bank was to assist in devising detailed plans, but a plan to encourage corporate financial restructuring was to be formulated only by late 1998. The urgency of corporate restructuring was recognized only at a later stage when problems in the financial system spread in the wake of the deepening domestic recession. In order to deal with the growing corporate debt problem, frameworks were developed for voluntary debt workouts between bank creditors and corporate debtors, and in some cases public financial contributions to the recapitalization of financial institutions were made conditional on progress with corporate debt workouts.14

In Indonesia, where the corporate sector accounted for the lion's share of external debt, the special problems of external corporate debt had to be addressed in talks with foreign bank creditors. These talks led to the establishment of a government exchange guarantee scheme—the INDRA scheme—which was subsequently complemented by a set of nonbinding guide-lines for debt workouts with domestic and foreign creditors (the Jakarta Initiative), but progress with corporate debt restructuring has, so far, been very slow.15 Similar guidelines were formulated in Thailand by the newly established Corporate Debt Restructuring Advisory Committee, and in Korea, financial institutions committed themselves to a binding framework by signing a Corporate Restructuring Agreement that involves arbitration.

The frameworks for corporate debt workouts in all three countries are, in essence, based on the “London Approach,” which describes a set of principles under which creditors agree to keep credit facilities in place, seek out-of-court solutions, work together, share all relevant information about the debtor, and recognize the seniority of claims.16 In addition, the three program countries have implemented or initiated a number of legal and regulatory reforms to facilitate corporate restructuring and enhance corporate governance, ranging from the elimination of cross guarantees in conglomerates in Korea to changes in prudential regulations regarding the treatment of restructured debt in Thailand. These legal reforms, in particular in the area of bankruptcy legislation, are an essential precondition for corporate debt restructuring to proceed. In the absence of the credible threat of foreclosure and bankruptcy procedures that define the rights of creditors and debtors, voluntary debt restructuring was unlikely to progress very far.17

The reform agenda for the financial and corporate sectors in the crisis countries is still evolving and it is too early for a detailed assessment of the multitude of measures that were planned and implemented. Nevertheless, the experience with financial and corporate sector restructuring during the first program year raises a number of important general questions regarding program design that can be addressed at this stage.

The overriding question is whether it was appropriate to place so much emphasis on structural measures in the financial and corporate sectors, which, at least in the initial phase, had to be developed under severe time constraints. The answer is clearly yes. Given the state of the financial system and the related difficulties in the corporate sector, which played a key role in the emergence of the crisis, the programs would have had little chance of success and little hope of gaining credibility without beginning a set of decisive steps to address these problems. Macroeconomic policies would have been undermined by the continuing deterioration of financial sector conditions, which was bound to lead to rapid liquidity expansion and a ballooning of quasi-fiscal deficits. Moreover, the ultimate goal of the programs—a quick return to sustainable growth—would not have been possible in an environment of protracted and deepening structural problems in the financial and corporate sectors.

Another important question is whether it would have been preferable to take more time to develop a comprehensive and detailed strategy—a precise roadmap—for the structural content of the programs rather than embarking without delay on a road for which only the broad outlines and some details of the first few miles were known at the outset. Given the nature of the crisis—a vicious circle of growing problems in the financial sector and a worsening macroeconomic environment—there was no alternative to the predominantly reactive approach that characterized policies in all three countries. Failure to begin to address the weaknesses of financial institutions early on would have implied a continuing rapid deterioration of financial sector conditions with attendant macroeconomic consequences; this likely would have deepened the crisis.

A number of lessons can be drawn from the experience with financial and corporate sector restructuring in the Asian crisis countries, lessons that should help streamline crisis management in the future. For one, the experience suggests that it would be highly desirable for the IMF and the World Bank to formulate policy guidelines on the key issues that need to be dealt with in the context of a financial sector crisis.18 For example, the experience with bank closures and subsequent bank runs in Indonesia raises questions about the initial policy on government guarantees: why did it differ fundamentally from the policy adopted in the two other program countries, even though (given widespread knowledge that the closed banks represented only a subset of a much larger number of insolvent institutions) the risk of bank runs in Indonesia was considerably higher? The policy was reversed two months later, but the problems encountered as a result of the initial approach contributed (along with other factors) to throwing the program off track.

Another important lesson from the experience in the Asian crisis is that measures to address deficiencies in the institutional and legal framework for financial sector restructuring need to be given high priority at the beginning of the process to avoid unnecessary delays. In addition, it needs to be recognized that corporate restructuring is a necessary complement to financial sector restructuring and frameworks for corporate debt workouts, as well as related reforms in bankruptcy laws and other relevant legislation, need to be introduced at an early stage.

An understanding on the need for early action in these areas, together with policy guidelines on key issues such as guarantees, the extent and form of regulatory forbearance, or the conditionality of liquidity support for distressed institutions, would help streamline the restructuring process and inform decisions on a variety of structural issues that have to be made in the midst of a crisis. At the same time, it must be recognized that, given the complexity of the issues involved and country-specific conditions that need to be taken into account, no amount of institutional wisdom will suffice to produce a straight-forward template for policies.

Financial and corporate sector restructuring tends to be a protracted process even under favorable circumstances. During this process, uncertainty about the state of the financial system and the corporate sector is likely to persist for some time and to influence market perceptions of private sector creditworthiness. Thus, there may have been an undue degree of optimism in the implicit assumption that market confidence would be significantly boosted in the short run by the combined policy and financing packages in the original Asian crisis programs.

Governance and Competition Policy

Reforms intended to improve governance and promote competition were a prominent aspect of the programs in the Asian crisis countries. It was recognized that the vulnerabilities in the financial and corporate sectors in these countries were attributable, in part, to deficiencies that undermined governance and market discipline: notably, the lack of well-defined and transparent accounting and regulatory standards, inadequate disclosure requirements, and complex formal and informal ties between government, financial institutions, and corporations.

Reforms to promote governance and competition in the program countries included dismantling state-sponsored monopolies and cartels; privatizing state enterprises that had served as vehicles of “crony capitalism”; strengthening competition laws; improving corporate disclosure requirements and increasing accountability to shareholders; increasing the transparency of economic and financial data; and restructuring or dismantling corporate networks (such as chaebol in Korea) that had limited the transparency of intercorporate dealings. To ensure that state enterprises were not merely sold into the hands of political insiders, competitive bidding procedures for privatization were established. Competitive bidding was introduced for government procurement as well. In addition, tax and regulatory structures that had led to distortions and misallocations of resources, including by bolstering monopolies, were reformed.

In Indonesia, efforts to improve governance and competition included a broad range of reforms ranging from the elimination of various types of formal and informal restrictive marketing arrangements to measures to enhance governance in state enterprises and prepare them for privatization. Box 8.2 illustrates the scope of these reforms. In Korea, policies focused in particular on strengthening shareholders' rights; eliminating government interference with bankruptcy procedures, mergers, and acquisitions; and enhancing the transparency of the business practices of conglomerates, including through restrictions on cross guarantees. In Thailand, the main emphasis has been on privatization. Preliminary work for the privatization of (and share divestiture from) public enterprises in the areas of energy, utilities, communications, and transport has been completed; a privatization secretariat has been established; and legislative measures needed to facilitate privatization of “noncorporatized” public enterprises have been proposed. In addition, work on the development of an adequate regulatory framework has been initiated.

In order to increase transparency in the public and private sectors, the programs included a number of measures to improve the quality, frequency, and timeliness of economic and financial data. These measures focused in particular on international reserves, foreign liabilities, and indicators of financial sector conditions, such as nonperforming loans and capital adequacy ratios. In addition, steps were taken to publish information on ownership structures and affiliations of financial institutions, and improve corporate accounting standards with a view to bringing them in line with internationally accepted practices. Efforts were also strengthened to ensure compliance by the end of 1998 with the IMF's Special Data Dissemination Standard to which the countries had earlier subscribed.

Current and Capital Account Liberalization

The programs in Indonesia and Korea included a number of measures to further liberalize external trade. The strategy typically focused on the continuation or acceleration of existing liberalization plans to prevent a lapse into beggar-my-neighbor restrictions—a tempting alternative at a time of crisis. In addition, trade liberalization measures were intended to support other measures aimed at promoting domestic competition. Indonesia accelerated the implementation of a comprehensive program introduced in 1995 to decrease most tariffs, reduce the number of products subject to special trade regimes, and gradually eliminate most nontariff barriers. Korea is planning to set a timetable for the elimination of trade-related subsidies, restrictive import licensing, and the import diversification program.19 Measures were also adopted to increase the transparency of import certification procedures.

Capital account liberalization was one of the more controversial structural policies in the programs, especially in Korea, given that excessive exposure to capital movements was viewed as one of the factors leading to the crisis. The crisis countries had taken important steps to liberalize their capital accounts prior to the crisis, and the IMF had generally encouraged such steps.20 However, in Korea, the way in which liberalization had been approached had contributed to its vulnerability. In particular, the experience of the crisis underscored the importance of appropriate sequencing to avoid creating distortions through selective liberalization of different types of flows, and the need for adequate standards of prudential supervision and regulation for institutions that have access to international capital markets.21 For example, the partial nature of the liberalization in Korea had encouraged short-term international borrowing by domestic financial institutions for on-lending to the corporate sector. Given the long-term efficiency benefits of capital account liberalization and the difficulty of reversing the process once it has started, the decision was made to move forward and remove the existing distortions through more comprehensive liberalization. Korea is speeding up its ongoing capital account liberalization program, including by eliminating restrictions on long-term foreign borrowing by corporations, pacing this with improvements in the supervision and regulation of the domestic financial sector.

Indonesia: Improving Governance and Competition

Notwithstanding steps to liberalize Indonesia's economy over the previous decade, at the time of the crisis there remained considerable limits on competition: in addition to barriers to foreign trade and investment, extensive domestic regulation restricted competition and supported monopolies or cartels in important sectors. A number of these restrictions intersected with governance issues, which added to perceptions of inequity and creating uncertainty for both domestic and foreign investors. Indeed, structural impediments to economic activity were seen as central to market concerns about Indonesia's future prospects.

Indonesia's program reflected these concerns, featuring not only measures to further liberalize foreign trade and investment but also domestic deregulation. An ambitious structural policy program prepared in cooperation with the World Bank therefore called for a number of fundamental changes:

  • An end to agricultural import ana domestic marketing monopolies and price controls, including the abolition of the monopoly of the state trading agency (BULOG) over the importation and distribution of essential food items. More generally, elimination of all formal and informal restrictive marketing arrangements.

  • In both retail and wholesale trade, elimination of restrictions on foreign investment.

  • Prohibiting provincial governments from restricting trade within Indonesia, and the elimination of provincial and local export taxes.

  • Release of farmers from requirements for the forced planting of sugar cane.

  • Measures to allow private participation in the provision of public infrastructure, with transparent and competitive bidding.

  • International standard audits of several large state enterprises.

  • Preparation of a law on competition.

Establishment of a competitive environment also requires procedures for the orderly exit of nonviable firms. Facilitating this were improvements in bankruptcy law and the establishment of a corporate debt Restructuring scheme.

Competition and governance were also to be improved by measures relating to the management and privatization of state enterprises. Among these were

  • Restructuring of state-owned enterprises, as a prelude to accelerated privatization.

  • Steps to sharply define responsibility and accountability for managing firms in the public sector.

  • Establishment of transparent procedures for divestiture and privatization.

Early in Indonesia's program, implementation of structural policies generally was very uneven; indeed, the authorities took a number of steps backward, especially in areas involving governance. A particular problem area was in exposing BULOG to effective competition—as, for instance, certain new subsidies were extended only to BULOG; in response, the program prescribed measures to level the playing field by offering the subsidies also to BULOG's competitors. (However, some discrimination in favor of BULOG remained.)

In general, as the program continued there was considerable progress in promoting competition, despite the inevitable resistance to dismantling policies that generate monopoly rents to be distributed to political insiders. Corresponding to these lost rents, of course, are gains to consumers and probably a more equitable distribution of income.

Social Sector Policies

Concerns about the effects of the crisis on the most vulnerable segments of society played a significant role in the programs from the outset, given the rudimentary formal social safety nets in the three countries.22 These concerns became more pressing, however, as it became clear that the down-turn in economic activity would be much harsher than initially expected. This prompted a series of additional measures to alleviate the impact of price increases and rising unemployment on the poor.23 Many of these measures, particularly in Thailand, were designed and financed with support from the Asian Development Bank and the World Bank. In addition, efforts were made to involve the affected parties in the development of social sector policies. In Korea, for example, reforms affecting the labor market and unemployment compensation were based on a Tripartite Agreement between the government, employer organizations, and trade unions.

Social Sector Policies in Indonesia, Korea, and Thailand1


Given the sharp contraction of economic activity and steep price increases clue to currency depreciation, a severe drought, and the disruption of supply channels in the wake of political unrest, social sector policies have focused on the availability of key commodities and basic services at subsidized prices, and on limiting unemployment.

Subsidies for food and other essential goods and services. While across-the-board subsidies are to be phased out, the program allowed for substantial increases in subsidies on essential foodstuffs such as rice, soybeans, sugar, wheat flour, corn, soybean meal, and fishmeal to stabilize prices. Subsidies on these products, except rice, had been eliminated (as they were found to benefit only traders, not consumers), but all fuel and electricity prices as well as low-cost housing continue to be highly subsidized; it is these subsidies that comprise the bulk of safety net spending. In addition, steps have been taken to rehabilitate the distribution system.

Health care and education. To support the provision of health care to the poor, a new subsidy scheme for essential drugs for rural and urban health centers has been introduced, and budgetary allocations for various health care projects have been increased. Measures to support education include a new scholarship program, grants to replace existing school fees, and an expansion of school lunch programs.

Employment generating projects. Community-based public works programs have been introduced in rural and urban areas, and special credit schemes for small enterprises have been expanded.


While still rudimentary by the standards of member countries of the Organization for Economic Cooperation and Development (OECD), Korea's social safety net is more developed than the corresponding systems in Indonesia and Thailand, which lack formal unemployment insurance schemes. Inflation has been kept in check, but unemployment has risen sharply as economic activity has contracted and existing restrictions on layoffs have been eased. To balance measures to increase labor market flexibility, social sector policies under the program have focused mainly on strengthening the unemployment insurance system, bringing it closer into line with other OECD countries.

Expansion of the unemployment insurance scheme. Coverage of the system has been broadened in steps from firms with more than 30 employees prior to the program to firms with more than 5 employees; the scheme now covers 70 percent of the labor force. In addition, the minimum level of benefits has been raised and the minimum duration of benefits has been increased. Eligibility for benefits has been expanded temporarily by reducing the minimum contribution period and raising the maximum duration of benefits.

Measures to support employment and training. Several programs have been introduced to encourage firms to resort to reduced hours and training instead of lay-offs, and training allowances provided under the employment insurance system have been increased. Public works programs have also been used to support employment.

Income transfers to the poor. Budgetary allocations for social welfare assistance, including support for persons without income, have been raised significantly.


While inflation has been kept under control, the sharp contraction in output and the associated increase in unemployment since the onset of the crisis has exposed the weaknesses of Thailand's very limited formal social safety net. Social sector policies, supported by the Asian Development Bank, the World Bank, and the Overseas Economic Cooperation Fund, have relied on a broad range of measures to mitigate the impact of the crisis on the poor.

Employment generating projects. Temporary civil works programs in construction and infrastructure rehabilitation have been initiated. In addition, two funds to support employment-creating investment projects in rural communities and municipalities are being established, and a program to promote rural industrial employment is being expanded.

Support for the unemployed. The severance pay provided by employers to dismissed employees has been increased to 10 months (for workers with more than 10 years of service), and an assistance fund to provide cash support to laid-off workers of bankrupt firms has been established. Eligibility for benefits under the limited social security system (medical, disability, and death) has been extended to the unemployed for up to 12 months. In addition, training programs and job placement facilities are being expanded.

Health and education. To support access to health care by the poor, financial support for community-based health care projects, particularly in rural areas, is being increased, and the public health insurance scheme for low-income groups is being strengthened. To preserve education standards, scholarship and loan programs are being expanded, and spending in key areas has been protected.

Price subsidies. Urban bus and rail transportation continues to be provided at subsidized fares.

1 The summary of social sector policies in this box refers to the programs as of mid-1998 (following the third review). Given initial expectations that the impact of the crisis on output and employment would be much less severe, the scope of social sector policies in the original programs was typically more limited.

While the focus of social sector policies in the three countries has varied, the programs typically included measures in four broad areas: measures to raise income transfers by strengthening and broadening the scope of existing social safety nets; measures to limit unemployment through government support for various types of employment and training schemes, as well as self-employment initiatives; measures to limit the impact of price increases on the consumption of poor households through new support schemes or the continuation of existing subsidies for basic goods and services, such as food, energy, and transportation; and measures to maintain access by the poor to health care and education (Box S3).24 In designing social sector policies, the programs sought to target assistance to protect the vulnerable while avoiding labor market disincentives and an unsustainable burden for the budget. Nevertheless, given the severity of the recession, significant increases in budgetary outlays for social programs were adopted, ranging from 2 percent of GDP in Korea to about 6 percent of GDP in Indonesia in 1998.

General Observations

Critics of the programs in the Asian crisis countries have argued that they suffered from an “overload” of structural reforms. Given the large and steadily widening structural reform agenda that had to be dealt with, this criticism cannot be dismissed lightly.25 While it is generally accepted that something had to be done to address the problems in the financial sector, measures to enhance governance and competition, liberalize trade and capital flows, and strengthen the social safety net have been seen as less central to the logic of the programs. However, while financial and corporate sector restructuring formed the core of the structural reform agenda in all three programs, supporting reforms in other areas played an important role. They were seen as needed to remove impediments to the efficient functioning of financial, goods, and labor markets, and to cushion the social impact of the crisis. As such, they were seen as important for the sustainability of the adjustment effort and an eventual return to sustainable growth. Important questions remain, however, regarding the appropriate pace and sequencing of reforms, and the emphasis on different areas of reform—as exemplified by the fact that, over time, the programs have tended to become more sharply focused on the core of financial and corporate restructuring.


Allbut two of the 58 finance companies that had been suspended in June and August 1997 were closed in December 1997.


Of the 14 merchant banks that were suspended in December 1997, 10 were closed at the end of January 1998.


As of November 1998, a total of 53 banks had been brought under the auspices of the Indonesian Bank Restructuring Agency (IBRA); of these, 10 were closed.


Banks that had made excessive use of central bank liquidity support were intervened (in Thailand) or placed under the auspices of IBRA (in Indonesia).


Shortly after the beginning of the program, the Korean government effectively nationalized two major commercial banks through large capital injections. Significant amounts of public funds were also made available through the Korea Asset Management Corporation, which acquired nonperforming assets from financial institutions, initially with little conditionality.


In Indonesia, IBRA was established in February 1998, but amendments to the banking act endowing it with legal power were passed by Parliament only in October. Moreover, there are doubts that these amendments are fully adequate for the efficient functioning of IBRA. In Thailand, the Financial Restructuring Agency (FRA) lacked for months the legal power to restructure the loans of the intervened financial institutions, thus delaying corporate restructuring.


In Thailand, for example, major initiatives such as a revision of the bankruptcy law and an emergency decree to facilitate bank mergers were still on the agenda more than one year after the beginning of the program. In Indonesia, legislation eliminating restrictions on foreign investment in banks and enabling mergers and privatization of state banks was passed only in October 1998.


These caps were formulated with reference to the rates offered by the strongest banks and were intended to prevent weak banks from bidding up deposit rates.


The guarantee referred to deposits up to the equivalent of about $5,000, covering over 90 percent of depositors but only 20 percent of the deposit base of the closed institutions.10 In Thailand, the agency that formally acts as lender of last resort is the Financial Institutions Development Fund, which operates under the auspices of the Bank of Thailand.


In Thailand, the agency that formally acts as lender of last resort is the Financial Institutions Development Fund, which operates under the auspices of the Bank of Thailand.


Section VI above discusses the role of banking system problems in derailing Indonesia's monetary program.


In Korea, the supervision of bank and nonbank financial institutions was unified at the beginning of the program, but different standards continued to apply to different types of institutions.


In Korea, attention focused on the lack of transparency and the high debt-equity ratios of large conglomerates (chaebol), in Indonesia, concerns centered on the state enterprises and numerous regulatory impediments to competition. The latter are discussed in the next section.


The recapitalization program announced in August 1998 in Thailand contains this type of conditionality.


Under this scheme, the Indonesia Debt Restructuring Agency (INDRA) acts as an intermediary between the domestic debtor and the foreign creditor in the servicing of renegotiated foreign debt. Debt-service payments are made to INDRA in domestic currency on the basis of a specified exchange rate, which is guaranteed in real terms. INDRA does not take on commercial risk and is not involved in actual debt workouts, which are to be guided by the principles outlined under the Jakarta Initiative.


The London Approach is used to guide voluntary debt Restructuring in the United Kingdom.


Bankruptcy laws were strengthened relatively early in Korea (February 1998) and Indonesia (April 1998), but much later in Thailand (October 1998).


Indeed, this has already begun under the Financial Sector Liaison Committee established by the two institutions.


Korea'simport diversification program requires importers to limit imports from countries that run a large bilateral trade surplus vis-a-vis Korea.


In Indonesia the capital account had been liberalized well before the crisis; the “free foreign exchange system” had been a pillar of economic policy for the past 30 years.


See, for instance, Johnston and others (1997).


Existing social safety nets in the three countries are described in Gupta and others (1998). They typically include some form of insurance for old age, disability, and death with very limited coverage and benefits; rudimentary health insurance and insurance for work-related injuries; and, in Indonesia and Korea, limited social assistance programs for poor persons without income and for particularly vulnerable groups. Of the three program countries, only Korea had a formal unemployment insurance system, which covered, however, only a small portion of the labor force at the onset of the crisis.


While it is difficult to estimate the impact of rising prices and unemployment on the incidence of poverty, staff calculations based on the World Economic Outlook suggest that the number of poor in Indonesia could increase by 5 to 11 percentage points of the population, in Korea by 2 to 12 percentage points, and in Thailand by 3 to 12 percentage points (see International Monetary Fund, 1998).


The different types of measures are summarized in Gupta and others (1998).


At the same time, the perception of overload may have been exaggerated by the fact that in several areas (such as corporate-governance and labor market reform) the intended reforms were to be planned with the assistance of the World Bank and the Asian Development Bank for implementation during the three-year period of the programs and beyond.


  • Gupta S., C. McDonald, C. Schiller, M. Verhoeven, Ž. Bogetic, and G. Schwartz, 1998, “Mitigating the Social Costs of the Economic Crisis and the Reform Programs in Asia,” IMF Paper on Policy Analysis and Assessment no. 98/7 (Washington: International Monetary Fund).

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  • International Monetary Fund 1998, World Economic Out-look, October 1998: A Survey by the Staff of the International Monetary Fund, World Economic and Financial Surveys (Washington).

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  • Johnston R. Barry, Salim M. Derber, and Claudia Echeverria, 1997, “Sequencing Capital Account Liberalization: Lessons from the Experiences in Chile, Indonesia, Korea, and Thailand,” IMF Working Paper No. 97/157 (Washington: International Monetary Fund).

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