ANNEX I

Asian Crisis Countries: Key Features of the Prudential and Regulatory Framework Before the Crisis

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Source: Khan and Reinhart (1995).

When implemented in 1994, the new law on foreign bank entry allowed three modes of entry for foreign banks: (1) the establishment of up to 10 new banks with full banking authority; (2) ownership of up to 60 percent of a new subsidiary; and (3) acquisition of up to 60 percent of an existing bank.

ANNEX II

Asian Crisis Countries—Main Elements of Structural Reforms

I = Implemented, in full or in part P = Planned C = Under Consideration N=Not under consideration NA=Not applicable

Introduced prior to 7/2/97.

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I = Implemented, in full or in part P = Planned C = Under Consideration N=Not under consideration NA=Not applicable

Asian Crisis Countries: Loan Classification Guildelines, 1998

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As defined by the period in which loans are considered past due or non-performing (typically 90 days). For Philippines, effective May 1, 1998 on monthly installment loans.

Or general provision. For Philippines, 1 percent by October 1, 1998 and 2 percent by October 1, 1999.

By April 15, 1999. For substandard loans the provisions are irrespective of whether the loans are collaterilized or uncollaterilized.

The new classification rules will be effective July 1, 1998, and provisioning rules, gradually over the period July 1998 to July 2000.

Specific provisions for large loans (above RM 1 million) are made on a case-by-case basis as determined by the bank’s examiner. All provisions are made against the uncollaterilized part of the loan.

ANNEX III

Summaries of Economic Adjustment Programs in Asian Crisis Countries
Indonesia

  • The initial program envisaged a broad-based program of financial sector restructuring; structural reforms including the liberalization of foreign trade and investment, dismantling of domestic monopolies, and expanding privatization; stabilizing the rupiah through tight monetary policy and a flexible exchange rate policy; fiscal measures—including cutting low priority expenditures, postponing infrastructure projects by the state enterprises, removing subsidies and adjusting administered prices of electricity and petroleum and removing VAT exemptions—equivalent to 1 percent of GDP in 1997/98 and 2 percent of GDP in 1998/99 to yield a public sector surplus of 1 percent of GDP in both years.

  • Due to a perceived lack of political will to follow through with the program, the weakness in confidence continued and the program was revised and reinforced in January to include adjustments in the 1998/99 budget that would result in a public sector deficit of 1 percent of GDP to accommodate part of the impact of the economic slowdown; further bank and corporate sector restructuring including an external debt resolution framework, the establishment of a bank restructuring agency; and a government guarantee of bank deposits and credits; eliminating key monopolies and other restrictive marketing practices; and measures to alleviate the effects of the adjustment on the poor.

  • Further policy slippages and reversals of policy commitments resulted in renewed pressure on the rupiah and inflation picked up sharply. The adjustment program was again modified in April 1998 to reflect the further deterioration in economic conditions with a targeted public sector deficit of almost 4 percent of GDP; negotiations for the resolution of external debt were accelerated; foreign ownership restrictions on banks were to be eliminated; a new bankruptcy law was to be issued; the authorities’ credibility was to be enhanced through the establishment of a council to monitor progress with program implementation.

  • The revised program, despite a promising start was driven off-track by the social disturbances and political change in May. A new program was negotiated in late June which gave the most urgent priority to repairing the distribution system and ensuring adequate supplies of food and other necessities to all parts of the country. The depreciation of the exchange rate, through its impact on the cost of subsidies and debt service, the further decline in oil prices and weakening of output all add substantially to the deficit. In addition, given the severity of the crisis and its disproportionate impact on the poor, there was an urgent need to strengthen the social safety net to alleviate the impact of higher unemployment and underemployment and the greater incidence of poverty. At the same time, there was a need to be mindful of the availability of financing. With these considerations in mind, the programmed deficit for 1998/99 was adjusted to be about 81/2 percent of GDP. In addition, bank and corporate restructuring was accelerated.

Korea

  • The initial program included the introduction of a clear and firm exit policy for financial institutions; suspension of insolvent banks; two commercial banks received capital injections from the government; and all commercial banks with inadequate capital were required to submit recapitalization plans; fiscal measures—including a widening of the tax base—equivalent to about 2 percent of GDP were to be introduced to make room for the costs of financial sector restructuring; the introducing of internationally accepted accounting, auditing and disclosure standards; trade and capital account liberalization measures; and the public dissemination of key economic and financial data.

  • As a decline in roll-over rates for Korean short-term debt placed additional pressure on reserves and the won, the program was intensified and the timetable accelerated. The revised program called for a further monetary tightening and abolition of the daily exchange rate band; speeding up liberalization of capital and money markets; acceleration of a comprehensive restructuring plan for the financial sector, including the negotiations with foreign creditors.

  • Amid signs of improving confidence, but weakening economic activity in early February, the program was modified to target fiscal deficit of 1 percent of GDP to allow the working of automatic stabilizers and to increase spending on the social safety net; liberalizing the corporate finance market; and strengthened measures to improve corporate transparency.

  • Against a background of substantial progress in alleviating the external financial crisis and rebuilding usable reserves and restoring some measure of stability to financial markets, in May, the program was refocussed on accelerating structural reforms in the financial and corporate sectors, and allowing automatic fiscal stabilizers to operate. The fiscal deficit was increased to nearly 2 percent of GDP.

Malaysia

  • The initial adjustment program unveiled in October 1997, which included a significant tightening of fiscal policy with an increase in the federal government and consolidated public sector surpluses to 2.6 percent of GDP and 3.3 percent of GDP respectively to be achieved mainly through cuts in expenditures; the maintenance of a tight monetary policy stance including through the introduction of a “credit plan” for banks and a gradual increase in interest rates; postpone of several large quasi-public infrastructure projects; and tightening of loan classification and provisioning guidelines.

  • In early December, in light of signs of sharper than anticipated economic slowdown and a more prolonged regional decline, the program was modified to include a further tightening of fiscal policy through additional expenditure cuts; a further gradual increase in interest rates; an accelerated program of mergers of finance companies assisted by the central bank; and a government guarantee of all bank deposits.

  • In late March, the program was again modified to include a smaller fiscal surplus reflecting the working of automatic stabilizers on revenues and the need to protect social sector spending; a comprehensive financial sector restructuring and rehabilitation strategy; the maintenance of a tight monetary policy; structural measures to improve governance and transparency.

  • In mid-July, in the face of a sharp contraction in growth in the first quarter of the year, the authorities announced a package of measures designed to forestall a severe recession. To that end, fiscal policy is to be eased, with a targeted federal government deficit of 3½ percent of GDP. At the same time, they have attempted to revive credit growth by lowering the statutory reserve requirement. The authorities also view the setting up of an Asset Management Corporation to take the bad loans off the banks’ books and a Special Purpose Vehicle to recapitalize banks as measures to ensure the revival of credit growth.

Philippines

  • The initial program focused on the strengthening of the fiscal position through tax reform and oil price deregulation. The program for 1998–99 calls for the maintenance of a strong fiscal position with the consolidated public sector deficit being held at

  • 1 percent of GDP in 1998 and move into balance in 1999; the maintenance of a tight monetary policy; and a comprehensive action plan of banking sector reform including raising bank capital, encouraging consolidation, tightening provisioning requirements and regulatory oversight, and longer-term capital market development; and measures to minimize the social impact of the current crisis.

Thailand

  • The initial program featured financial sector restructuring focused on the closure of 56 finance companies and intervention in the weakest banks; fiscal measures—including an increase in the VAT rate—equivalent to 3 percent of GDP to correct the public sector deficit to a surplus of 1 percent of GDP in 1997/98; and several structural measures to reinforce the economy’s outward orientation including liberalization of foreign capital inflows.

  • In light of the sharp economic slowdown and the adverse regional developments, the program was modified to include additional actions to prevent a deterioration in the fiscal position; establishment of a specific timetable for implementing financial sector restructuring; and acceleration of plans to help the most vulnerable groups in the economy.

  • Again, early in 1998, the program was adapted to take into account the negative social impact of the larger-than-anticipated slowdown and to give clear priority to stabilizing the exchange rate including an adjustment in the fiscal target from a surplus of 1 percent of GDP to a deficit of 2 percent of GDP in response to the weaker economic activity and larger-than-anticipated improvement in the current account and to finance higher social spending; ensuring adequate availability of credit to productive sectors of the economy while maintaining a tight monetary stance; and accelerating financial system restructuring.

  • The program was further revised in May 1998 with a focus on consolidating the recent exchange market stability, including the possibility of a cautious reduction in interest rates over the coming months if the signs of stability persist. In addition, the revised program targets a larger fiscal deficit of about 3 percent of GDP (excluding the cost of financial sector restructuring); acceleration of the process of consolidation of the finance companies and amendments of the bankruptcy law. Finally, foreign investment liberalization is to be facilitated through changes in the legal framework.

ANNEX IV

Table A.

Asian Crisis Countries: Selected Economic and Financial Indicators

(Averages, in percent of GDP, unless otherwise indicated)

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Sources: WEO and staff estimates.

All ratios are in percent of GNP, unless otherwise indicated.

Non-oil tax revenue.

For 1991–95, December 1995 over January 1991. For 1996, December 1996 over December 1995. For 1997, December 1997 over December 1996.

12-month change to February 1998.

Includes errors and omissions.

Includes commercial banks’ net foreign liabilities. For Philippines, percent of adjusted gross reserves.

Table B.

Asian Crisis Countries: Key Economic Indicators, 1990-99 1/

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All data are on a calendar year basis.

Weighted by GDP valued at purchasing power parities (PPPs).

Table C.

Asian Crisis Countries: External Adjustment, 1996-98

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Monthly export data exclude non-oil and gas; monthly import data exlude oil and gas.

Table D.

Asian Crisis Countries: Key Program Indicators, 1996-98

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Source: Data provided by country authorities; and staff estimates.

Original program refers to the first program negotiated with the authorities after the onset of the crisis. For the Philippines, the program already in place last July was envisaged to run through end-1997.

Revised program refers to the latest revision of program targets.

Base money growth adjusted for changes in reserve requirements

Thirty-day interbank rates or nearest comparable rates. For 1998, data shown are for end-June.

In percent of GNP

Usable reserves

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1

This paper is based on information available through June 1998. The authors are grateful for the substantial inputs from Ilan Goldfajn on the discussion of interest rates and monetary policy and to Ioana Hussiada for excellent research assistance. The paper also draws on inputs from Andrew Berg and Patricia Reynolds, and benefits from suggestions from David Robinson, Kanitta Meesook, Steven Phillips, Christopher Morris, and various commentators from FAD, MAE, PDR, and RES.

2

For the purposes of this paper, the crisis countries are defined to include Indonesia, Korea, Malaysia, the Philippines and Thailand, that is, those whose currencies and financial markets came under the most severe pressure in the aftermath of the floating of the Thai baht.

3

Empirically, the role of factor accumulation versus productivity growth is unclear. Researchers such as Young (1993) and Krugman (1994) argue that Asian growth was largely due to capital accumulation, while others find evidence of substantial productivity growth.

4

This is the core of Krugman’s (1998) thesis that the implicit government guarantee of banks’ liabilities in the crisis countries created a moral hazard problem by fueling excessively risky investment and over-investment at the economy-wide level. In doing so, these guarantees created a banking system that was very vulnerable to asset price declines.

5

Official estimates of nonperforming loans are much lower (about 6 percent at end-1997).

6

This is largely because these tend to be lagging indicators of true asset quality and tend to underestimate the extent of problems, especially in periods of high growth, and when loan classification standards and safeguards against such practices as “evergreening” are weak.

7

Ahmed and Loungani (1998) present evidence on the importance of terms-of-trade movements and changes in oil prices for output fluctuations in Asian economies. Fernald, Edison and Loungani (1998) and Noland, Liu, Robinson, and Wang (1998) study the trade linkages between China on the one hand, and Asian crisis countries on the other; both studies conclude that while there is trade competition between the two, it is unlikely the renminbi “devaluation” of 1994 played an important role in triggering the current Asian crisis. The suggestion that competition from Mexico may have been a significant adverse external shock is made by, among others, Sachs, and Radelet (1998).

8

The correlations are qualitatively similar over a longer period 1973 to 1996, and are robust to the inclusion of other variables in the export equations such as foreign demand growth.

9

See Berg (1998) and IMF (1997) for a detailed discussion of the onset and spread of the crisis.

10

The framework for this discussion is drawn from IMF (1998) and Masson (1998).

11

The United States is used in this illustration because of the availability of fairly disaggregated data on Asian exports. Although the United States accounts for roughly 20 percent of total exports of the affected countries, it is one of the main markets in which they compete closely on the product side. See Fernald, Edison and Loungani (1998), who also document the export competition among the Asian crisis countries in Japan and in major European markets.

12

Goldstein (1997) refers to this as the “wake-up call” effect.

14

Most of these measures were removed within a short period of time in Thailand.

15

The programs with Thailand, Indonesia and Korea were approved in August, November and December 1997, respectively. The Philippines already had a Fund-supported program in place before the crisis; the program period was extended and financial support under the program was augmented in July 1997. In March 1998, a new precautionary stand-by arrangement was approved for the Philippines. Malaysia does not have a Fund-supported program but the Fund has been in close touch with the authorities as they have formulated their own comprehensive policy response to the crisis.

16

It should be noted that, especially in the aftermath of the Mexico crisis, the Fund had emphasized the need for stronger and more transparent regulatory frameworks and more effective bank supervision, sound financial systems, improved information disclosure and strengthened governance as conditions for the achievement of sustainable growth.

17

Detailed information can be found in the tables in Annex IV.

18

Real interest rates are, of course, very difficult to measure. For the purposes of this discussion, survey data on expected inflation and the widely reported 12-month inflation rates are used as two measures of inflationary expectation.

19

Data for 1998 have been provided by country authorities on a preliminary basis and run through May for all countries, except Indonesia where data are only available through the first quarter. Also, data for Indonesia refer to non-oil and gas trade.

20

The decline in imports is projected to moderate in the second half of 1998, so that the staff’s projections for the full year in 1998—to be presented in the forthcoming WEO—will be somewhat lower than the annualized outturn from the first few months of the year.

21

In many cases, actual volume and price data for 1998 are not available and had to be estimated. In addition, there appear, in some cases, to be large discrepancies in export volume growth as reported by exporting and importing countries.

22

Since this paper was written, a new wave of turbulence—the so-called “second crisis” or “crisis within a crisis” arising mainly from weaknesses in Japan and weaker-than-expected growth performance in the original crisis countries—has gripped financial markets in Asia, leading to renewed pressure on the exchange rate and further declines in stock markets.

24

Ghosh and Phillips (1998) use daily data since mid-1997 and a simple equation—in which the change in the exchange rate in each country is regressed on the average exchange rate change in the four other affected Asian countries and on the change in the interest rate—to examine the correlation between movements in interest and exchange rates. The study finds that there is a link between raising (lowering) interest rates and a strengthening (weakening) of the exchange rate. The link is slightly stronger if the sample is restricted to periods during which interest rates were reduced. A major difficulty in such an exercise is, of course, the potential for significant downward bias in the coefficient on the interest rate because of the possibility that interest rates are changed in response to exchange market pressures.

The East Asian Crisis: Macroeconomic Developments and Policy Lessons
Author: Ms. Kalpana Kochhar, Mr. Prakash Loungani, and Mr. Mark R. Stone