East Asian Financial Crisis- Tarun Das

East Asian Economic Crisis and Lessons for Debt Management Dr. Tarun Das*, Economic Adviser, Ministry of Finance

1. Anatomy of the Crisis The crisis unfolded against the backdrop of three decades of outstanding economic performance in East Asia. These economies, particularly Indonesia, Malaysia, Philippines, South Korea and Thailand recorded very high growth rates during 1980s and early 1990s. However, most of the countries had recently large current account deficit, financed by capital flows attracted by the region’s economic boom, macro-economic stability, interest rate differentials and stable exchange rate. East Asia became the darling of international investors since the 1980s, and the advancement of computer and information technology speeded up capital movements from one market to another for higher returns. A part of the impetus for the increased capital flows to the East and South East Asia also originated from the crisis of commercial banking in major industrial countries to find alternative sources of business and to enhance returns of capital (UNCTAD, 1998). Private sector companies were the main borrowers abetted by a euphoric environment created by liberalisation of financial markets without strengthening the regulatory and supervisory systems. There was close links between government, business and banks. Companies borrowed easily foreign currency on short terms and lent too rapidly for use in unproductive sectors. Lending was based not on feasibility of projects but on personal relations or “crony capitalism”. The chaebols in Korea, the politically well connected monopolies in Indonesia and the influential private corporations in Malaysia are examples of such links (Kochhar et. Al. 1998). Surge of foreign capital inflows led to an over-extension of lending, a decline in the quality of assets and laxity in risk evaluation and portfolio management by the financial sector. Capital inflows financed investment booms in: •

•

• • •

protected or illiquid sectors having low return and long gestation period (real estate and petrochemicals in Indonesia, Thailand, Malaysia) causing maturity mismatch between assets and liabilities of the financial intermediaries, Sectors with high or excess capacity having low or negative returns (steel, ships, semiconductors, automobiles in Korea), Non-tradables (such as land, office blocks and condominiums in Thailand) that generate return in domestic currency and did not generate foreign exchange; Directed lending by chaebols in Korea to maintain their market shares in automobiles and electronics with inadequate attention to profitability, and Speculative and unproductive lending in share markets.

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The paper expresses personal views of the author and does not necessarily reflect the views of the Ministry of Finance, Government of India.

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The whole system set the stage for a classic boom-bust cycle in asset markets. Stock and property prices soared initially then plunged leading to the currency and financial crisis. These prices plunged even more after the crisis, and led to deep and wide spread economic crisis and social chaos. The financial intermediaries, both banks and non-bank, were the creators of this asset cycle. Liabilities of these financial intermediaries were perceived as having an implicit government guarantee, but they were essentially unregulated. They borrowed large amounts of international capital, much of which was on short-term maturity, denominated in US dollars and not hedged against currency risks. They lent money to highly leveraged speculative investors, mostly in real estate. The excessive risky lending by these institutions created inflation of asset prices. The overpricing of assets and over-investment were sustained by a sort of circular process, in which proliferation of risky lending led to an increase in prices of risky assets. There was a serious mismatch of assets/ liabilities of banks and their financial intermediaries. Their financial conditions seemed sounder than the real balance sheet position. It led a fragile financial system with illiquid and undercapitalised assets. Finally, there was a burst of price-bubbles in the middle of 1997 leading to a significant fall of asset prices in all the crisis economies. As the asset prices fell further, it became increasingly doubtful whether governments would really stand behind the deposits and loans that remained. Both the depositors and lenders rushed to withdraw their money. Foreign investors stampeded to recall their loans and investments, forcing currency devaluation. It worsened the crisis even further as banks and companies found them stuck with illiquid assets in devalued Baht or Rupiah, but with liabilities in US dollars. Finally, the financial crisis was converted into wider economic disruption and social chaos. 2. Origins of the Crisis The difficulties that the East Asian countries face are not primarily the result of macroeconomic imbalances. Rather, they stem from weaknesses in financial systems and, to a lesser extent, governance. Although private sector expenditure and financing decisions led to the crisis, it was exacerbated by governance issues, notably government involvement in the private sector and lack of transparency in corporate and fiscal accounting and the provision of financial and economic data. Thus, the build-up to the difficulties in East Asia, which eventually lead to the present economic and financial crisis in these economies and elsewhere, can be traced in four major factors: •

These countries were, to some extent, victims of their own economic success: High growth and commendable economic success resulted in underestimation of risk combined with inadequate financial sector supervision;

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•

Various features of their external economic environment (such as dependence on exports of automobiles and electronics), that at first were favourable, turned sour in several respects in 1996 and 1997;

•

Shortcomings and inconsistencies in domestic macroeconomic and exchange rate policies; many countries in the region maintained a policy of stable exchange rate for a long period despite deceleration of exports, and pursued a policy of relatively high interest rates in order to maintain a stable exchange rate;

•

Various structural weaknesses, particularly in the financial sector, that made these economies and especially their financial systems increasingly fragile and vulnerable to adverse developments.

It may be observed from the Table-1 that there were serious macro-economic imbalances on the eve of the crisis in all the crisis economies. They became increasingly vulnerable in 1997 to external shocks for the following reasons: •

The current account deficit as a per centage of GDP ranged between 2 per cent in Korea to 5.2 per cent in Philippines.

•

External debt as a per centage of GDP ranged from 34 per cent in Korea to 76 per cent in Indonesia.

•

Share of unconcessional debt to total debt ranged from 77 per cent in Philippines to 94 per cent in Malaysia.

•

Share of short-term debt in total debt ranged from 19 per cent in Philippines to 62 per cent in Korea.

•

Share of short-term debt in total foreign exchange reserves ranged from 47 per cent in Malaysia to 75 per cent in Korea.

•

Although foreign exchange cover of imports ranged from 0.6 months in Korea to 4.7 months in Indonesia, practically all foreign exchange reserves were sold off in large forward contracts on the foreign exchange markets particularly in Thailand (Karin Lissakers 1998).

Banking sector was subject to high risk and vulnerability to adverse shocks for the following reasons: •

Ratio of domestic credit to GDP rose to 165 per cent in Korea, 160 per cent in Malaysia and 157 per cent in Thailand.

•

Interest expenses as a per centage of GDP ranged from 14 per cent in Philippines to 25 per cent in Thailand.

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•

Debt to equity ratio reached nearly 400 per cent in Korea compared with 85 per cent in Taiwan, 144 per cent in Germany, 160 per cent in Malaysia, 154 per cent in Sweden, 200 per cent in Japan and 150 per cent in USA.

•

On the eve of the crisis, short-term interest rates rose to more than 16 per cent in Korea and 22 per cent in Thailand.

•

In 1997, banks’ exposure to property sector was 34 per cent in Indonesia, 26 per cent in Malaysia and 13 per cent in Thailand.

•

Non-performing loans of commercial banks reached 19 per cent of total credits in Thailand, 16 per cent in Korea and Malaysia, and 17 per cent in Indonesia compared with 1 per cent in the USA (IMF 1988).

The situation was exacerbated by the weakness in corporate and public sector governance. Total (domestic and foreign) debt of private and private sectors amounted to 190 per cent in Indonesia, and exceeded 225 per cent of GDP in Korea, Malaysia and Thailand. In Korea and Thailand, incremental capital output ratios (ICORs) doubled in 1990-1995. Debt to equity ratio increased to nearly 400 per cent in Korea in 1997. In Korea, the net profits of 30 largest chaebols were close to zero, with six chaebols filing for bankruptcy in early 1997. 3. Onset and Spread of the crisis World was astonished with the speed and extent to which the crisis spread from Thailand to other countries in the region. The financial and exchange rate crisis, that began in Thailand in mid 1997, spread to many countries of East Asia, Russia, parts of Latin America and also affected the economic health of major industrial economies like Japan, North America and Europe. Contagion or the Wake up call effect and slipover effects through intraregional trade and investment linkages have been felt by many emerging market countries in other region in the form of declining stock prices and intense pressures on exchange rates, It has adversely affected their economic growth prospects in 1998 and outlook for future. The crisis has led to dramatic depreciation of the nominal exchange rates (Table-1). The sharp movement of the exchange rate has greatly complicated the macroeconomic policy choices by raising the cost of repaying foreign debt, weakening the financial and corporate sectors. Remarkably, the CPI inflation rate since June 1997 has been in the range of 5-12 per cent with the exception of Indonesia, where the current inflation is running around 80 per cent. Mexico, by way of comparison, experienced a 40 per cent surge in inflation during first ten months of its crisis in 1995. Despite large increases in nominal interest rates in some countries, only Korea and Thailand have been able to maintain real interest rates as significantly higher levels than those before the crisis. For the crisis-hit East Asian economies real GDP growth rates in 1998 are predicted to be negative, ranging from -5 per cent and -6 per cent in some

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countries like Thailand to -10 per cent to –15 per cent for Indonesia. These countries continue to incur massive social and economic costs in terms of loss of output, acceleration of inflation, rising unemployment, and growing poverty. Main causes of economic recession: Four main factors as indicated below are responsible for the current recession: (a) Lack of external demand as a result of several factors such as: •

An effective collapse of the regional market as a result of decline of imports by 4 to 13 per cent in volume. The crisis countries (and these including Japan) accounted for 45 per cent (and 55 per cent) of the exports to the region. This explains that the performance in volume (between negative 0.6 per cent for Indonesia, 5 per cent Malaysia and 24 per cent for Korea) is much lower than the pre-crisis level.

•

Prices of exports also declined significantly leading to very low performance in value, given the decline in exchange rates. Export value declined in Malaysia and Indonesia, and increased by only 1.4 per cent in Thailand and by 5 per cent in Korea.

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(b) Lack of internal demand as a result of several factors such as: • • • •

Loss of wealth (market capitalisation down by 16 per cent in Indonesia, to 145 per cent in Malaysia); Capital flight equivalent to about 10 per cent of GDP; Increase in unemployment and number of people below the poverty line, and loss of revenues by the working population. None of this has been compensated so far by sharp increases in public demand, either in terms of investment or current expenditures on social sectors.

(c) Problems on the supply side: The corporate sector face considerable difficulties in responding to demand, mainly due to collapse of financial sector. There is also the problem of trade finance and internal credit crunch due to various factors such as: • • • • •

Lack of competitiveness, and industrial restructuring taking time (Korea, Thailand); Corporate distress due to sharp increase of foreign debt (Indonesia) or high real interest rates (everywhere except in Indonesia); Decline in bank credits as banks reduce their exposure because of capital adequacy requirements, and not enough capital to lend; No credit available for specific categories of enterprises such as SMEs because banks supporting them collapsed. In general SMEs were hit more than large exporting corporate houses. Each country was, in effect, exporting its recession to its neighbours and there was no obvious engine of growth to pull the region from recession.

(d) Political and social factors: Political and social events also played a significant part in the crisis. While political changes in Thailand and Korea assisted in stabilising of the exchange rate, with the establishment of a clearly understood and supported reform programme, political uncertainty in Indonesia played an important role in the opposite direction. There were signs of social unrest almost everywhere, although by different degrees. Unemployment rates are now 3 per cent in Malaysia, 6 per cent in Korea and 15 per cent in Indonesia. Poverty is therefore increasing at an alarming rate. Indonesia, which had an impressive record of poverty reduction, is expected to experience a rise in the poverty ratio from 11 per cent to about 16 per cent within a year (World Bank 1998). The poor are being severely hurt during the crisis as demand for their labour falls, prices of essential commodities rise, social services are cut, and crop failures occur due to weather shocks. Social areas, including ensuring food and medicine supplies, keeping children in school, and protecting women’s health are key targets for interventions by the government and multilateral funding agencies. 4 Impact on Indian Economy

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Indian economy remains relatively less affected by the recent economic crisis in East Asia and elsewhere. After achieving an average growth rate of about 7 per cent per annum during the Eighth Plan (1992-1997) and 7.7 per cent per annum in 1994-1997, growth rate of real GDP declined sharply to 5 per cent in 1997-98. But, the deceleration of the overall growth rate in 199798 was mainly attributed to domestic factors such as a decline in agricultural value added by 1 per cent and sluggish growth in industrial value added at 5.9 per cent in 1997-98. External factors had only marginal impact on the growth rate of India, as the dependence of GDP on external trade is very limited. Overall growth rate of GDP is expected to improve to 5.8 per cent in 1998-99 supported by a growth rate of 4.7 per cent in industry, 5.3 per cent in agriculture and 6.7 per cent in services. Growth rate of exports in US dollar decelerated sharply from 20.3 per cent in 1995-96 to 5.6 per cent in 1996-97 and further to 2.1 per cent in 1997-98. The current account deficit as per centage of GDP increased from 1.1 per cent in 1996-97 to 1.6 per cent in 1997-98. Despite pressure on exchange rate and sluggish exports, balance of payments position has remained comfortable during 1998-99. Foreign exchange reserves (including gold and SDR) at the end of January 1999 stood at $30.4 billion, which provides cover to about seven months of imports. The build up of foreign exchange reserves during 1998-99 was mainly attributable to the successful launching of the Resurgent India Bonds by the State Bank of India in August 1998 leading to an inflow of $4.2 billion worth of foreign currency assets. Portfolio investment has continued to decline from $3.3 billion in 1996-97 to $1.8 billion in 1997-98, to a net outflow of $0.8 billion in April-December 1998; but this decline has been offset by buoyant inflows of foreign direct investment in 1997-98. Inflows of foreign direct investment increased by 19 per cent and reached $3.2 billion in 1997-98. However, in 1998-99 the inflows of direct foreign investment amounted to only $1.6 billion in April-December 1998, indicating a decline by 38 per cent over the flow of FDI in the corresponding period of the previous year. Stock of external debt increased by $1 billion from $93.4 billion at end-March 1997 to $94.4 billion at end-March 1998. However, debt service ratio to total current receipts declined from 21.2 per cent in 1996-97 to 19.5 per cent in 1997-98 and the debt to GDP ratio remained stable around 23.8 per cent in 1996-97 and 1997-98. The ratio of short-term debt to total debt declined from 7.2 per cent at end-March 1997 to 3.7 per cent at end-September 1998. The Indian economy has demonstrably withstood the firestorm of capital flight from emerging economies. This is attributable to a number of favourable factors, such as: • • • •

Sound macroeconomic management, Strict fiscal prudence and monetary discipline, Deregulation and delicensing in industry and trade to encourage private investment, Liberal policy of foreign direct investment and portfolio investment, 8

• • •

Limited convertibility of Indian Rupee on capital account, Firm control on short-term external borrowing and Lack of large exposure of Indian banks and financial institutions to speculative and illiquid sectors such as real estate and share markets.

Considerable comfort to investors is provided by important indicators on the external front such as the following, which are very favourable as compared with those in the crisis economies (Table-1). • • • • • • • • • •

Current level of foreign exchange reserves is equivalent to 7 months of imports. Total foreign debt as a share of GDP has declined to 23.5 per cent. Concessional debt has a high proportion (41 per cent) of overall external debt. The debt service ratio continues to decline, and is now 18.5 per cent. The share of short-term debt in total foreign debt is less than 4 per cent. As per centage of foreign exchange reserves, short-term debt is about 12 per cent. Current account deficit at around 1.5 per cent of GDP is manageable. Internal debt of the Central Government as per centage of GDP has shown a declining trend, and presently stands at 46 per cent of GDP. Average Non Performing assets of the Indian banks are 9 per cent. Average debt equity ratio of he Indian banks is only 100 per cent. Indian banks have low risk as domestic debt to GDP ratio is only 23 per cent, and interest expenses constitute only 3 per cent of GDP. 5 Lessons from the Asian Crisis for Macro-economic management Including management of external debt

In a comprehensive study of the East Asian crisis, Kochhar, Loungani and Stone (1988) have grouped policy lessons into two categories: policy lessons for crisis resolution and those for crisis prevention. The lessons for crisis resolution include the importance of tight monetary policy early on for exchange rate stabilisation, flexible fiscal policy, and comprehensive structural reform. Crises are avoided by prudent macro-economic policies, diligent bank supervision, transparent data dissemination, good corporate governance, and forward-looking policy, even in good times. Broad policy lessons for macro-economic management including management of external debt, that emerge from this paper and other studies by the World Bank (1998), IMF (1998a to 1998e) and UNCTAD (1998), are summarised below: (a) General policies •

The Asian crisis has highlighted the importance of a sound macroeconomic policy framework, and the dangers of unsustainable large current account deficits.

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Basic lesson from the crisis is that the sooner the problems are identified, recognised and properly treated, the better the chances for being successful, and the smaller the economic and social costs involved. The problems are always worse than expected. This seems to be true for both monetary policy and financial and banking reforms.

•

The odds for the occurrence of a financial crisis can be reduced by better macroeconomic fundamentals, complemented by appropriate legal, regulatory and institutional set-up for effective prudential regulation, monitoring, surveillance and supervision of the financial system and improved corporate governance. These entail structural reforms with an unavoidably long-time scale.

•

The main responsibility for taking appropriate measures to contain the economic damage lies with the countries directly affected. Hesitation in the implementation of required adjustments and reform measures could only worsen the crisis; cause markets to overshoot even further and exacerbate contagion effects.

•

Goal should be to promote financial system based on stable economic policies, sound financial system, open current accounts and transparent behaviour by both the public and private sectors. The reforms should aim at minimizing the risk of occurrence of a financial crisis and to ensure that we do have adequately early warning and effective policy tools to deal with the crisis.

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(b) Financial sector reforms •

The linchpin of the crisis is the weak banking and financial system, which has constrained the monetary authority in conducting monetary policy and banking supervision as well as facilitating payments system.

•

A few lessons for the financial sector reforms are now evident. First, worst time to reform a financial system is in the middle of a crisis. Second, when currency turmoil is associated with financial difficulties, raising interest rates over an extended period may simply worsen the situation by bringing about widespread corporate and bank insolvency. Third, currencies should not be left to sink while funds are used to bail out the international creditors.

•

The Indonesian experience teaches that when public expectation is fragile, the closure of insolvent banks, even though a must for creating a sound banking system, could have an adverse result. A step, which was originally intended to regain public confidence, resulted in a further loss of confidence. It precipitated the translation of what was initially a liquidity crisis into a solvency crisis, leaving behind a large stock of unpaid debt. It may not be realistic, but the liquidation of weak banks should be done when the economy is not fragile. And, in general, the sooner the better.

•

Banking reforms need to be co-ordinated with monetary reforms. There are interaction and feedback effects between bank soundness and macroeconomic policy choices. Conflicts between the aims of price stability and bank soundness entail an inter-temporal trade-off.

•

Disclosure of key information on performance, credits, profitability etc. of both financial and corporate entities is essential for creating investors’ confidence. Transparency provides markets with accurate information, creates confidence and healthy competition among economic agents.

•

We need to encourage good practices and to allow financial markets to differentiate among bad, good and better borrowers and lenders. This would help reduce the so-called “herding behaviour” that has been one of the causes of increased contagion during the crisis. (c) Monetary policies

•

Monetary policy in general is a short run issue, even though it has longterm implications. Banking restructuring is, however, a long-term problem. It deals with problems of efficiency, management, supervision, regulation, law enforcement, banking ethics, etc., which are microeconomic issues. These have to be considered carefully in designing and implementing banking reform together with monetary policy.

•

Monetary policies need to be kept sufficiently firm to resist excessive exchange rate depreciation through adequate increase in interest rates,

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its inflationary consequences and downward pressures on partner countries’ currencies. For economies with large amounts of short-term external debt, it is particularly important that monetary conditions provide adequate incentives for the private sector to roll over short-term foreign loans in the face of the increase in risk premium. •

Monetary policies can be used for reducing inflows of short-term debt or changing the composition of capital inflows in favour of long-term flows. One such measure is to introduce or enhance non-remunerated reserve requirement deposited with the central bank on liabilities in foreign currency arising from borrowing by firms depending on the maturity of the loan. There can be also an explicit tax on inflows of foreign capital, irrespective of maturity and purpose. It is also possible to impose quantitative controls on capital such as fixation of prudential limits on or prohibitions of non-trade related swap activities, offshore borrowing, ceilings on banks’ foreign currency liability or sale of short term money market instruments to foreign residents (Islam 1998).

•

Generally, a tight monetary policy is required to defend a currency, which is under severe downward pressure. Higher interest rates not only raise return on investment from assets denominated in foreign currency and thus encourage inflows of foreign currency assets, but also reduce speculative demand for foreign currency by making it more expensive. Tight monetary policy also reduces domestic demand and expectations of future inflation and helps to support the exchange rate.

•

However, tight monetary policies increase the debt burden in domestic currency and the fiscal deficit, which may put downward pressure on the exchange rate when foreign lenders and investors perceive greater credit risks. Therefore, a tight monetary policy may be avoided as far as possible or may be used only temporarily in an economy with relatively large domestic debt burden. Short periods of relatively high interest rates are, however, may be needed to stabilise wide exchange rate fluctuations when speculative demand is high and confidence is lacking. (d) Fiscal policies

•

Fiscal policies need to contribute to the mobilisation of domestic savings and to encourage the flow of non-debt creating financial flows and thereby reducing the country’s excessive reliance on foreign debt. To the extent that fiscal benefits are provided to foreign investors or the fiscal adjustment strengthens international confidence, it can also help reverse capital outflows thus reducing the need for current account adjustment.

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Fiscal policy needs to strike a balance between different objectives such as growth with stability, equity and economic justice. It need to protect the interest of the vulnerable sections of the society, to expand the social safety net, to accommodate costs of financial sector restructuring and to relieve the burden of the current account adjustment on the private sector. 12

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Fiscal deficits were allowed to increase considerably in all crisis countries, alleviating the effects of the crisis on real activity. This fiscal expansion reflects accommodation of the deterioration in fiscal positions resulting from the recession and exchange rate depreciation.

•

Objections that no fiscal tightening was needed because the crises were made by the private sector and not the result of “government profligacy” are valid: even if fiscal policy was not part of the initial problem, it was a useful part of the solution. (e) Sequencing capital account convertibility

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It is necessary to foster orderly and properly sequenced capital account liberalisation (supported by a sound financial sector and appropriate macroeconomic and exchange rate policies) in order to maximise the benefits from and minimise the risks of free capital movements.

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The liberalisation of capital accounts should be done in an orderly and sequenced manner in line with strengthening of domestic financial systems through adequate prudential and supervisory regulations (Goldsbrough 1998). The golden rule is to encourage initially non-debt creating financial flows such as foreign direct investment and portfolio equity investment followed by long term capital flows. Short term or volatile capital flows may be liberalised only at the end of capital account convertibility.

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Most of the affected countries imposed capital controls in response to the financial market pressures. If retained beyond the short term, the costs of unilateral controls are likely to outweigh the benefits and can impose significant risks to other members of the international community. A strategy of integration, rather than isolation, clearly offers more benefits in the long run. (f) International co-operation

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International economic and financial co-operation is essential to contain the crisis. The major advanced economies should seek to maintain supportive conditions in international financial markets. In particular, in Europe and North America, there may be a need for timely monetary easing to arrest an escalating downturn.

•

Collaboration and consultation at the regional and bilateral level are also capable of contributing to the prevention of financial crisis. Their potential role is particularly important with respect to the prevention of currency disorders and contagion effects.

•

Changes are needed to the global economic and financial architecture in view of the excessive volatility of short-term debt

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flows, strong contagion effects of crisis, and increased moral hazard in international financial markets. (g) External Debt Management Strategy •

As mentioned earlier, in all the East Asian crisis economies, weaknesses in financial systems as a result of weak regulation and supervision and a long tradition of a heavy government role in credit allocation led to misallocation of credits and inflated asset prices. Another vital weakness of all countries was associated with large unhedged private short-term foreign currency debt in a setting where the private corporate sector was highly leveraged.

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Short-term foreign currency denominated debt created two kinds of vulnerabilities in these economies. First, if some creditors pulled out their money, each individual creditor had an incentive to join the queue. As a result, even a debtor that had been fully solvent before the crisis could be plunged into insolvency. Second, such debts also created vulnerabilities associated with the exchange rate depreciation. Exchange risk was either borne directly by the financial institutions or passed on to the corporations as the funds was on lent (thereby converting exchange risk into credit risk). These factors were further complicated by the interaction of exchange rate and credit risks. Currency depreciation led to wide spread insolvency and created additional counter-party risk, which in turn added momentum to the exit of foreign capital.

•

The management of debt crisis being faced by the East Asian countries is not without precedence. Following the inception of the Latin American debt crisis in 1982, and on the presumption that the debt problem was one of liquidity and not solvency, the initial debt management strategy aimed at normalising the relationship between the debtors and creditors through a combination of economic adjustment by debtor countries and negotiations on financial relief. The financing modalities provided debtor countries with some financial relief through interest rate spreads, reduced fees, extension of maturities and provision of some new finances. The negotiations conducted on a case-by-case approach for debtor countries were co-ordinated by the private bank steering committees in consultation with the IMF, World Bank and governments of the creditor banks’ home countries (Islam 1998).

•

In the context of the current Asian crisis, countries have been succeeded in striking a reasonably comprehensive debt-rescheduling strategy with creditor banks. The implementation of the deal is voluntary and all creditors have not joined the scheme. So long as free movement of international capital is allowed, there is no guarantee that the debt crisis will not recur in future. Whenever such a financial crisis occurs in future, it is necessary to formulate an international debt management strategy on the basis of negotiations among international private lenders, investors and borrowers for sharing the responsibility for debt relief, for rescheduling or for delaying claims on repayment.

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More effective structures for orderly debt workouts, including better bankruptcy laws at the national level and better ways at the international level of associating private sector creditors and investors with official efforts are needed to help resolve sovereign and private debt problems.

•

In the case of the present East Asian crisis, considerable thought is being given to mechanisms that involve private sector to forestall and resolve crisis in a more timely and

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systematic way. A range of options are available in this respect, viz. (a) to contract credit and swap facilities with groups of foreign banks, to be activised in the event of liquidity pressures, such as those contracted by Argentina and Mexico; (b) embedding call options in certain short-term credit instruments to provide for an automatic extension of maturities in times of crises; (c) feasible modifications of terms of sovereign bond contracts to include sharing clauses; and (d) a possible role for creditor councils for discussion between debtors and creditors. However, these are complex issues and need to be designed carefully so that there are no perverse incentives, which may encourage private creditors to bail themselves out at the first sight of difficulty, rather than providing net new financing in the event of a crisis. •

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Developing countries need to strengthen their debt management strategy by developing comprehensive debt sustainability models, which will integrate external sector, particularly the flows of external debt, with broad macro-economic variables and provide early warning regarding any possible debt trap. In this respect, separate debt models may be developed with respect to sovereign external debt and private debt. •

All countries need to monitor very carefully short-term debt, long-term debt by residual maturity, all guarantees and all contractual contingent liabilities arising out of both debt and non-debt creating financial flows.

•

A more comprehensive approach is needed when trying to deal with excessive private borrowing and risk taking in the presence of large capital inflows and weak financial systems. This often means applying more flexible exchange rates, tighter fiscal policy and improved financial system. Domestic financial sector liberalisation should also proceed carefully and in step with tighter financial regulation and supervision, and internationally recognised prudential norms for capital adequacy and provisioning for non-performing assets by commercial banks and financial institutions. We can conclude with the following observations made by the World Bank in their Report on Global Economic Prospects and the Developing Countries (1999):

“The most pressing issue is to develop better mechanisms to facilitate private-to-private debt workouts, including standstills on external debt under some conditions, and to restore capital flows and increased international liquidity to countries in crisis. Although there are some compelling arguments for a lender of the last resort, difficult issues arise for appropriate burden sharing, the rules for intervention, and the avoidance of moral hazard. Improved regulation by creditor country authorities and better risk management of bank lending to emerging markets should also help reduce probability of crisis. More timely and reliable information is desirable, but complete transparency and better information alone will not prevent a crisis”. “The main lessons of the crisis are that countries need to build and strengthen regulatory and institutional capacities to ensure the safety and stability of financial systems, especially at the interfaces with international financial markets; and that the international architecture to prevent crises and deal with them needs to be strengthened more effectively”.

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Table-1: Major macro-economic variables in India and East Asian countries in 1997 (In per centage, unless mentioned otherwise) Items

India

1. GDP growth in 1997 2. GDP growth in 1998 3. GDI to GDP ratio 4. GDS to GDP ratio 5. Current a/c deficit to GDP 6. External debt to GDP ratio 7. Concessional debt as a ratio to total external debt 8. Short-term debt as a ratio to total external debt 9. Debt-service ratio 10. Short-term debt as a ratio to foreign exchange reserves 11. Foreign currency assets (months of imports) 12. Exports of goods & non-factor services as a ratio to GDP 13.Banks exposure to real estate 14. NPAs of banks 15. Short term interest rates As on 2nd December, 1998 16. Domestic credit to GDP ratio 17. Bank credit to public sector as per cent to GDP 18. Debt/equity ratio 19. Interest expenses to GDP 20. Currency depreciation since July 1997 until Nov.98 21. Fall in REER since June 1997 22. Fall of stock prices since July 1997 23. CPI inflation rate as in October 1998 24. Central government balance 25. Internal debt at the end 1997 as per centage of GDP

Korea

5.0 5.8 24.8 23.1 1.6 24 41

Indonesia 4.6 -12.0 29.5 27.1 2.4 76 20

5.5 -5.0 36.8 34.8 2.0 34 …

Malaysia 7.8 -4.0 42.8 38.0 4.8 44 6

Philippines 5.1 0.5 23.9 18.7 5.2 57 23

Thailand - 0.4 -6.5 35.0 32.9 2.2 59 8

5

25

62

28

19

41

19 17

31 103

9 751

6.3 47

11 134

15 112

6.9

4.7

0.6

3.5

1.7

4

16

30

37

94

40

48

34

16

26

27

13

17 48.9

16 7.7

16 6.6

13 13.4

19 7.5

21 3

63 5

165 10

160 10

90 25

157 2

100 3 15.5

250 19 70

400 21 32

. 15 34

. 14 34

. 25 30

3 34

57 58

31 48

29 62

25 38

29 37

16.3

79.3

6.8

5.2

10.2

4.1

-5.5 49

0.8 46

0.0 …

2.6 32

-1.0 85

-1.0 19

Negligible 9 9.5

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Table-2: Basic Indicators of the Indian Economy 1991-1998 (In per cent) Variables 1990- 1991- 1992- 1993- 1994- 1995- 199691 92 93 94 95 96 97 GDP growth rate 5.4 0.8 5.3 6.2 7.8 7.6 7.8

199798 5.0

199899* 5.8

Agricultural growth

3.7

-2.0

4.1

3.8

5.4

0.2

9.4

-1.0

5.3

Industrial growth rate Infrastructure growth rate Savings/GDP ratio

8.2

0.6

2.3

6.0

9.3

12.2

6.0

5.9

4.7

4.8

6.1

2.5

5.0

9.1

7.9

2.6

4.8

2.5

22.3

21.0

20.3

21.8

24.2

24.1

24.1

23.1

23.5

Investment/GDP ratio Fiscal deficit/GDP ratio (Central govt) Internal debt/GDP ratio (Central govt.) CPI inflation rate

25.5

21.5

22.1

22.4

25.4

25.8

25.7

24.8

25.0

7.7

5.4

5.2

6.9

5.6

4.9

4.7

5.5

6.0

48.6

47.4

46.8

49.1

47.0

45.6

44.1

45.9

45.8

11.6

13.5

9.6

7.3

10.3

10.0

9.4

6.8

10.0

Capital issue (Rs.bn)

43

58

198

195

264

161

104

31.8

…

Market cap (Rs.bn)

1103

3541

1771

3983

4331

4710

4639

4910

5000

Exports growth rate

9.2

-1.1

3.3

20.2

18.4

20.3

5.6

2.1

0.5

Current A/C as % of GDP Forex currency assets ($ bn) FER cover (no. Of months) External debt/GDP ratio Non-debt capital as ratio total cap. flow Debt-service ratio

-2.9

-0.3

-1.7

-0.4

-1.0

-1.6

-1.1

-1.6

-1.4

2.2

5.6

6.4

15.1

20.8

17.0

22.4

26.5

26.8

2.5

5.3

4.9

8.6

8.4

6.0

6.5

6.9

7.0

27.3

37.7

36.6

33.1

30.0

26.3

23.8

23.8

23.5

1.2

2.9

13.2

42.9

60.0

155.4

56.6

48.2

21

35.2

30.2

27.5

25.6

26.2

24.3

21.2

19.5

18.5

10.2

8.3

7.0

3.9

4.3

5.4

7.2

5.4

3.7

147

77

65

19

17

23

25

17

12

0.1 0.1 0

0.1 0.1 0

0.6 0.3 0.3

4.2 0.6 3.6

4.8 1.2 3.6

4.6 1.9 2.7

5.8 2.5 3.3

5.0 3.2 1.8

2.0 2.2 -0.2

Short-term debt as % of total external debt Short-term debt as % of FE assets Foreign invest ($ bn) Foreign direct inv. Portfolio investment * Projection by the author.

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Selected Bibliography Atkinson, Caroline (1998) Persistence of Asia crisis underlines need for reforms, Economic Perspectives (Electronic Journal), September 1998, United States Information Service, New Delhi. Butsuntorn, Tawee (1999) The future direction of manufacturing industries in Asia after economic crisis, pp.67-74, in Asian Economic Crisis: In Search of Higher Competitiveness in Global Markets, Asian Productivity Organisation, Tokyo, 1999. Fischer, Stanley (1998) Reforming world finance- lessons from a crisis, IMF Survey, Special Supplement, October 19, 1998; reprinted from the October 3, 1998 issue of the Economist, London. Goldsbrough, David (1998) Architecture of the international financial system, paper presented in the Study Meeting on the Asian Economic Crisis: In Search of Higher Competitiveness in Global Markets, 15-16 December 1998, organised by the Asian Productivity Organisation, Tokyo. International Monetary Fund (1998a) World Economic Outlook Financial Crises, Causes and Indicators, May 1998, Washington D.C. _______ (1998b) World Economic Outlook and Global Policy Challenges, September 24, 1998, Washington D.C. _______ (1998c) How has the Asian crisis affected other regions?, Finance and Development, Volume 35, Number 3, September 1998, Washington D.C. _______ (1998d) Mitigating the social costs of the Asian crisis, Finance and Development, Volume 35, Number 3, September 1998, Washington D.C. _______ (1998e) World Economic Outlook – Financial Turbulence and the World Economy, September 30, 1998, Washington D.C. _______ (1998f) Fund-Supported Programs in the Asian Crisis, November 25, 1998, Washington D.C. Islam, Azizul (1998) The dynamics of the Asian economic crisis and selected policy implications, paper presented at the Expert Group Meeting on “What have we learned one year into the emerging market countries financial crisis?” 21-23 July 1998, United Nations, New York.

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Kochhar, Kalpana; Loungani, Prakash, and Stone, Mark R. (1998) The East Asian Crisis: macroeconomic developments and policy lessons, IMF Working Paper.WP/98/128, August 1998, International Monetary Fund, Washington, D.C. Lissakers, Karin (1998) The IMF and reforming the global financial architecture, Economic Perspectives (Electronic Journal), September 1998, United States Information Service, New Delhi. Neiss, Hubert (1999) IMF in Asian monetary crisis: current and future, pp.1-17, in Asian Economic Crisis: In Search of Higher Competitiveness in Global Markets, Asian Productivity Organisation, Tokyo, 1999. Reddy, Y. V. (1998) Managing capital account, address at the Second South Asia Forex Dealers Association Conference, October 1, 1998, Hyderabad, India. Ruggiero, Renato (1998) Beyond the financial crisis, address by the WTO Director General to the Council on Foreign Relations in New York on October 5, 1998, Press Release no. Press/113 dated October 6, 1998, WTO, Geneva. Sadli, M (1999) The Asian crisis and the way to recovery, pp.25-35, in Asian Economic Crisis: In Search of Higher Competitiveness in Global Markets, Asian Productivity Organisation, Tokyo, 1999. Stiglitz, J.E. (1998) South Asia beyond 2000: lessons from East Asia and elsewhere, Keynote Address to South Asia Beyond 2000, Colombo, Sri Lanka, 19 March 1998. UNCTAD (1998) Trade and Development Report, 1998 - Financial Instability and Growth in Africa, United Nations, New York and Geneva. World Bank (1998a) Social Consequences of the East Asian Crisis, September 30, 1998, Washington D.C. World Bank (1999) Global Economic Prospects and the Developing Countries, December 1998, Washington D.C.

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