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Last Updated: 5-Jun-98
Council on Foreign Relations
THE COUNCIL TAKES NO INSTITUTIONAL POSITION ON POLICY ISSUES AND HAS NO AFFILIATION WITH THE U.S. GOVERNMENT. ALL STATEMENTS OF FACT AND EXPRESSIONS OF OPINION CONTAINED IN ALL ITS PUBLICATIONS ARE THE SOLE RESPONSIBILITY OF THE AUTHOR OR AUTHORS.
On April 15, 1998, the Council on Foreign Relations hosted its spring corporate conference on "The Asia Crisis: Economic and Political Implications." With a keynote address by Anwar Ibrahim, Malaysia's Deputy Prime Minister and Finance Minister, and 28 speakers representing 9 countries, the event drew an audience of 250 for a full day of discussion and debate on the causes and effects of the financial crisis in Southeast Asia.
The complete conference program is included at the end of this report.
As a follow-up to the conference, the Council commissioned Lawrence B. Krause, professor-emeritus at the Graduate School of International Relations and Pacific studies, University of California, San Diego, to prepare two reports. The first was a summary of the highlights of the spirited discussions during the various conference sessions. This was circulated shortly after the event and posted on the Council's web site. It is included at the end of this volume.
The second report, which follows here, was prepared by Professor Krause as an independent, scholarly account of the crisis. He covers the roots of the crisis, its impact on the individual countries most seriously affected, the controversial role of the IMF, assesses which other economies - notably China and the United States - might be vulnerable to a similar fate, and concludes by drawing lessons for the future.
The essay was written in the six weeks following the conference, and thus addresses subsequent developments, including, most notably, the resignation of President Suharto. It does not attempt to report or summarize the discussions at the Council's conference, although the author's participation in the proceedings and discussions with fellow participants clearly inform his conclusions.
The Council would like to acknowledge, in addition to Lawrence Krause, the individuals and organizations directly responsible for the success of the April 15 conference.
We are especially grateful for the support of the conference's sponsors, Archer Daniels Midland Company, A.T. Kearney, Citibank, Alliance Capital Management International, AIG, American Express, The Boeing Company, Goldman, Sachs International, Salomon Smith Barney Asset Management, Texaco Inc., Caterpillar, and the Arthur Ross Foundation.
The Asian financial crisis of 1997-98 continues to attract tremendous interest on the part of both financial specialists and academics. The Asian crisis has several facets that fascinate observers. First, it is an economic and political crisis as well as a financial upset, unlike the crisis that hit Europe in 1992-93. Second, the most seriously impacted countries (MSIs)--Thailand, Indonesia, and Korea--were until recently being congratulated for their economic miracles. Can miracle makers turn into miscreants overnight? Third, there is a suspicion that the crisis has been mishandled by the International Monetary Fund (IMF), the government of Indonesia, and the monetary authorities of Thailand, Korea, and Taiwan. Misdeeds are always interesting to investigate. Finally, some observers believe that the crisis is more a consequence of the volatility of global financial markets than of the problems of individual countries. If that is true, then is it possible that other countries now enjoying excellent economic performance--such as the United States and China--could suffer a similar fate in the future?
This essay is broadly addressed to five issues. It begins with a discussion of the general causes of the crisis. Attention is then directed to individual countries, including Japan and China along with the MSIs. Next follows a discussion of the role of the IMF and the United States in the crisis. The consequences of the Asian financial crisis are then addressed. The essay concludes with a discussion of possible lessons for the future.
The author wishes to thank all of the members of the ad hoc graduate student/faculty seminar on the Asian financial crisis at the University of California, San Diego, including Martin Beaversdorf, Peter Gourevitch, Allen Hicken, Stephan Haggard, Miles Kahler, Euysung Kim, Andrew MacIntyre, Kitirat Panupong, Daniel Pinkston, João Mariano Saldanha, and Van Whiting
Financial markets were taken by surprise on July 2, 1997, when the Bank of Thailand withdrew its support of the baht in the foreign exchange market and the baht plunged in value, setting off the Asian financial crisis. Writing after the fact, Giancarlo Corsetti, Paolo Pesenti, and Nouriel Roubini examined a host of macroeconomic indicators for nine countries in East Asia and concluded that it was clear by early 1997 that the value of several regional currencies could not be sustained.[1] This conclusion rested mainly on the judgment that those currencies had become overvalued during the 1990s, that the countries were recording large and growing current account imbalances, and that official foreign reserves were inadequate to withstand a speculative attack. By implication, they criticized the market for not recognizing the signs that a crisis was coming.
Writing before the fact in the annual Pacific Economic Outlook (PEO), 1997-1998,[2] a group of economic forecasters from within the region expressed their growing concern over the financial situation by including a special section in their report on the balance of payments of all PEO economies for the decade of the 1990s. They recognized that the ratios of current account deficits to gross domestic product (CAD/GDP) for many economies were growing and becoming alarmingly high. All three of the MSIs were seen to have CAD/GDPs greater than 3 percent. The forecasters in their risks-to-the-forecast section of the report even identified Thailand as a special case of domestic financial fragility . Nevertheless, they did not forecast the crisis.
The Asian financial crisis was not forecast for good reason. If one were to compile a list all the countries in the world with high and growing current account imbalances, the list would be enormous. Some countries within the same region as the MSIs, such as Australia and New Zealand, have been untouched by the crisis. Indeed, every country in Latin America with the exception of Venezuela and Honduras had a worrisome current account imbalance in 1997, yet the contagion did not spread to the Western Hemisphere. Other economies, such as those of Hong Kong and Singapore, were strongly affected by the crisis even though they had only a small deficit or even a large current account surplus. Moreover, both Thailand and Korea in the early 1990s managed without much trouble to finance even larger CAD/GDP ratios than they faced later. It is thus reasonable to conclude that international financial crises are difficult to start and take unpredictable courses, and that forecasters will avoid making dire pronouncements that crises are imminent for fear of being considered fruitcake prophets out of the main stream or accused of benefiting from a crisis that they might start.
As distinct from a purely domestic financial problem, an international financial and economic crisis occurs only when both domestic and foreign investors lose confidence in the foreign exchange value of a currency. That loss of confidence then exacerbates structural economic weaknesses--something fundamental in the economy has gone badly wrong. The origin of a crisis matters, especially in the political dynamics that it sets off. The economic and political crisis was set off by an international financial debacle that has its own characteristics. Historically, such crises have usually occurred after an inflationary period in which the prices in one country's economy persistently exceed those in other countries, particularly those with whom it has close trading relations and with whom it competes. Indeed, hyperinflation is the variable that dominates all others in its ability to set off a currency crisis. It should be noted, however, that this was clearly not the case with the Asian financial crisis. Inflation in the economies of East Asia was under reasonably good control. Certainly the MSIs were not standout problems in this regard.
Instead, one must look to a combination of factors to explain the Asian financial crisis. It may well be that four factors were involved, and all must be present for a crisis to be triggered. There must be simultaneously a technical condition, an external debt condition, a financial fragility condition, and a political uncertainty condition. Once a crisis is triggered, contagion takes over and becomes the most important factor in the threat to similarly situated countries. Thailand was the country with all four conditions present before the Asian financial crisis; the others only "qualified" after contagion hit them.
Technical Condition
The first factor that contributes to a financial crisis is that a currency is significantly overvalued. This can only happen if the monetary authorities are unwilling to let the currency depreciate in a timely and orderly manner. Determining overvaluation is not simple to calculate and requires much subjective judgment. Thus if only a relatively slight amount of overvaluation is suspected--say less than 10 percent--market players are unlikely to make a run on the currency because the risk/reward ratio is unattractive. It is a different story, however, if the overvaluation is believed to be 20 percent or more.
Corsetti, Pesenti, and Roubini rely on indices of real effective exchange rates published by J. P. Morgan in making their determination of significant overvaluation.[3] If market participants decide that overvaluation is present and begin to sell the questioned currency for foreign currency and the monetary authorities choose to resist the pressure, then the monetary authorities must intervene in the foreign exchange market. If the market is convinced that the currency is seriously overvalued and continues to sell it, then eventually the central bank will run out of its owned reserves and all the foreign currency it is willing or able to borrow. When the currency plug is finally pulled and the currency is free to float, it usually overshoots on the downside because the price decline itself attracts momentum speculators and panics unsophisticated investors. The crisis continues until the undervaluation attracts investors and speculators on the other side.
External Debt Condition
The second factor that is needed for a crisis is a rapid and substantial build-up of short-term foreign debt. If a current account deficit is entirely financed with, or results directly from, an inflow of real long-term capital such as foreign direct investment (FDI), then the soundness of a currency is rarely questioned. This is because the foreign capital results in an investment that in time can provide a flow of foreign currency returns sufficient to service the foreign debt. Any long-term foreign borrowing that leads to investment in tradable goods and services usually is of this kind. Such is the current situation in Vietnam, which has the highest CAD/GDP ratio among the Asian economies, yet has hardly been touched by the Asian financial crisis.
In contrast, if short-term borrowing is relied upon to finance a current account deficit, then serious concerns are raised as to whether the debt can be repaid. These-short-term debts can be either those of the public sector, the private financial sector, or even the private nonfinancial sector. Short-term debts are constantly being reviewed and can reverse direction quickly. Thus if short-term capital is being relied upon and access to additional amounts begins to be problematic, then the conditions for a reverse flow are created that can initiate a currency crisis. It often happens that much short-term debt is taken on by either the government or the private sector in the months immediately before a crisis, which aggravates the situation tremendously. The crisis will only end when foreign bankers are convinced that financial stability has returned and that the government or private sector will be able to repay the foreign debt despite and because of its lower-valued currency.
Financial Fragility Condition
The third factor is disarray of public finances, or the existence of fragile private domestic financial institutions. The two often go together, but this was not the case in Asia, where government budgets had low deficits or were even in surplus. In the Asian MSIs, the private finance companies and banks were fragile, and their condition combined with weak prudential oversight by their governments. These are really two sides of the same coin because banks cannot become overextended if the regulatory authorities are doing their job properly.
One of the distinguishing characteristics of the so-called Asian model of development is close and cooperative relationships between the government and private business. A danger arises if the relationship becomes too close and prevents effective competition in markets from developing. Such distortions are particularly damaging to an economy when the financial sector gets so involved that prudential oversight is undermined. Favors are solicited to overlook bad situations, not sound ones.
Banking is a deceptively complex business, and it along with other financial services are changing rapidly. If a high-risk-taking financial sector has been permitted to grow up, then some sort of financial upset will occur--notice the savings and loan (S&L) crisis in the United States. Overlending by banks is matched by overborrowing by nonfinancial firms. Persistently high real-growth rates of an economy reward firms that are highly leveraged and encourage overborrowing by firms in the fastest growing industries. If for any reason interest rates should rise dramatically, then financial distress is bound to ensue.
If a domestic financial sector is protected from foreign competition, it is most likely that domestic firms will not be aware of the full risk they carry in their lending activity. If liberalization of regulations permits domestic financial institutions to gain access to foreign markets before adequate prudential oversight is in place, then the economy is really asking for trouble.
Weak banks will face a liquidity squeeze when interest rates rise sharply; this is an inevitable consequence of a run on the currency. The run can turn into a panic if domestic financial institutions are forced to close. Foreign banks will quickly pull lines of credit and demand repayment of maturing loans if they begin to question the soundness of their counterparty. The crisis can only be ended when a working domestic financial system is reestablished. This may well require injections of foreign money into the domestic financial system, which could result in its falling under foreign control. This is what happened in Argentina.
Political Uncertainty Condition
Political uncertainty is often recognized by financial analysts but rarely appreciated as a necessary condition for the triggering of a financial and economic crisis. Markets clearly do reflect political variables.[4] Evaluating the political scene is a necessary step in a foreign investment decision. No due diligence report would be complete without evaluating the prospects for future economic policy and the wisdom and power of policymakers. When politics change, markets react. Thus politics and political uncertainty can be elements in triggering a financial crisis. Indeed, it may well be a necessary condition for a crisis, and it differentiates those countries with worrisome economic indicators that suffer a crisis from those with the same indicators that escape it.
Political uncertainty means that private participants in the economy can no longer anticipate what economic policies are likely to follow. This may result from an absence of trust and confidence in the government, from a belief that the existing political regime may not last, or from other factors.
An example of how political differences can impact a financial upset can be seen in the contrast between the handling of the S&L crisis in the United States and the collapse of the financial bubble in Japan. The U.S. political system is often characterized as subject to deadlock because of the checks and balances built into the system by the constitution, while Japan does not have that limitation upon decisive action. Nevertheless, the results were just the opposite. In the United States, where trust in the government is limited and sometimes absent, the people through their elected representatives nevertheless endorsed the use of public money to resolve quickly and effectively the S&L problem. They probably anticipated correctly that some undeserving people would be made rich and the innocent middle-class would pay the bill, but they trusted government processes sufficiently to accept the government's policy judgment. The government concluded that a public bailout was desirable and that its implementation would prevent the financial problems of the past from infecting the economic prospects of the future.
This was not the case in Japan. The Japanese public was unprepared to permit public resources to be used to bail out banks and nonbank lending institutions from severe difficulties arising from their bad loans during the 1980s. The public felt that the government was not to be trusted to help large banks, which were viewed as already receiving too much largesse at public expense, and strongly resisted rescuing them from their mistakes. As a result, the Japanese banking system has not been restructured, and the economy has stagnated throughout the 1990s.
Almost all capitalist countries have suffered through a severe financial problem at one time or another. Markets overshoot, external shocks occur, and honest policy mistakes are made, but well-run governments that command the confidence of the people usually manage to roll with the punches. Overcoming a financial challenge usually requires prompt action by the government to stabilize the situation through the use of public resources. To do this, a political consensus must be formed (or already exist) to support the proposed government program, and the government must be capable of implementing the program quickly.
Forming such a consensus must overcome the inherent difficulty that policy actions of this sort have important distributional consequences. Someone's ox is bound to be gored. What makes losers willing to accept their fate? Sometimes they have no choice, and they search for ways to extract retribution. Where trust and confidence in political processes exists, however, losers are willing to suffer an immediate setback because they believe that the system provides distributional justice over time. The solution of any one game can be unbalanced if players are convinced that immediate sacrifices are recorded and that balance will be restored through repeated games. The societal trade-off is between distributional justice in the present or past versus economic efficiency and growth in the future. It takes confidence in the government on the part of the losers to accept the later outcome.
If there is little confidence in political processes and if losers have blocking power, then they will surely exercise it and keep necessary reform from being implemented. This results in political deadlock when decisive action is required. If the situation is serious and worsens with time, then only an extreme market reaction can change the status quo. A financial cum economic crisis can only occur if there is some sort of government failure. Either the government is unable to formulate a rescue plan, or the public is unwilling to accept it, or policymakers are unable to get the bureaucracy to implement it properly. Somewhere there must be a breakdown in the political process.
Government failures cannot be hidden from financial markets. Investors and speculators will become uncertain when they cannot anticipate the economic policy that will be implemented. Uncertainty will have an impact on reasonably cautious investors by dissuading them from making commitments in the questioned currency. Similarly, speculators will be attracted by possible gains and will be tempted to short the currency. If there is an event that focuses the market on government weakness, then the crisis can be rather sudden. The crisis can only end when the uncertainty over economic policy is resolved.
Contagion
Once a financial crisis is triggered, contagion can take over. There is both a technical and a psychological dimension to contagion. On the technical side, the equilibrium value of a currency is changed when the currency of a trading partner is significantly depreciated. A currency that previously was in a sensible trading range could become overvalued if a major currency in its reference basket takes a fall. If a currency was marginally overvalued previously, then it is bound to draw unwanted attention almost immediately.
The psychological dimension of contagion may be even more powerful than the technical. The market that previously was responding only to good news and ignoring the bad could overnight start to do the reverse. News always comes in mixed bags. The balance between the good and the bad has more to do with how news is perceived than with its inherent characteristics. Like other asset markets, currency values are driven by expectations, not by history. The impact of news on expectations depends very much on how it is spun by analysts. After a significant depreciation, it is quite natural for analysts to emphasize bad news, which tends to undermine confidence in allied currencies. Furthermore, analysts will begin to search for bad news that was previously ignored or hidden from the public. Revelations spread the contagion.
Investors and goods traders that were happy to hold unhedged foreign liabilities when the market was upbeat will be quick to cover themselves when a nearby currency depreciates. This may be more important in spreading contagion than the actions of traditional speculators.
The Thai baht depreciated sharply on July 2, 1997, and unleashed the Asian flu on the region, and the flu turned out to be more virulent than it first appeared. Despite efforts by the Philippine central bank to shore up the peso's value by raising interest rates, the peso came under great speculative pressure and was permitted to float on July 11. By July 21, the IMF had renewed its program for the Philippines and enlarged its line of credit.
The contagion spread to the Malaysian ringgit on July 14. The first response by the Malaysian prime minister was to blame the problem on foreign speculators. The market reacted negatively, as this response was viewed as ignoring some of the real problems in the Malaysian economy. Subsequently, Malaysia responded more conventionally and effectively to stabilize its financial circumstances. For example, the very expensive project to create a new administrative capital was delayed. Although the Malaysian ringgit did devalue along with the Thai baht, Malaysia was able to reestablish stability without the help of the IMF and without conditions being put on its ability to determine its own economic policy.
The contagion also spread to the Indonesian rupiah and the Singapore dollar on July 14. In the case of the rupiah, much more was to follow, but in the case of the Singapore dollar, the disturbance was merely an adjustment based on its usual weighted basket. Thus all of the principal ASEAN currencies caught the Asian flu immediately. As noted below, this was only the first, not the last, outbreak of the disease.
Participants at the IMF meeting in Hong Kong in September 1997 might well have concluded that the crisis was over. Volatility in both stock and exchange rate markets had been reduced, and the IMF was fully engaged. The temporary calm was destroyed, however, on October 17, when the Bank of Taiwan announced that the new Taiwanese (NT) dollar was being devalued by 15 percent.
In the first three months of the crisis, Taiwan had been forced to use several billions of dollars in its reserves to support the NT dollar, but the government was in no danger of running out of reserves as its stockpile was huge and it was running current account surpluses. Thus Taiwan was accumulating net foreign assets even as it was losing official reserves. The decision to devalue was based on an appraisal of Taiwan's competitiveness, which was seen as having been weakened by the devaluation of ASEAN currencies. Rather than easing down the currency's value over a long period of time as it had done in the past, the government decided to devalue in one step to avoid the complications of managing monetary policy with a depreciating currency. This decision turned out to be a mistake.
When the NT dollar was depreciated, it brought the attention of investors and speculators to the currencies of issuers that compete with Taiwan. The Hong Kong dollar was the first to feel the pressure. The Hong Kong monetary authorities were determined not to break their currency's strong link to the U.S. dollar. In order to keep the Hong Kong dollar at 7.8 dollars per U.S. dollar, interest rates were raised in several steps. The authorities demonstrated that they would raise interest rates to whatever level it took to support the exchange rate. Obviously, higher interest rates have a huge impact on equity markets, and the Hang Seng index dropped by over 30 percent. This reverberated through equity markets in Europe and then to the United States--where the Dow Jones index took its largest one-day drop ever--and then back to Asia. Although equity markets recovered rather quickly, the Asian flu was revived with great vigor.
All international financial crises generate contagion, including the "tequila effect" of Mexico's crisis in 1994-95. Nevertheless, the tequila effect was quite limited, as only Argentina was affected to any great extent. Not so the Asian flu. What accounts for the difference? Several factors may be responsible, including mismanagement, but the most important reason may well be the impact of developments in China and Japan--the two largest economies in Asia--which had no counterpart in the earlier episode in Latin America. For several years and through different mechanisms, China and Japan had been putting tremendous pressure on the entire Asian region. This trend may account for the virulence of the Asian flu.
It was through its sharply improved competitiveness that China had a great impact on the region, particularly on the ASEAN countries. China has been taking tremendous strides toward industrial modernization for many years. In 1994, China unified its two-tiered foreign exchange market and in the process sharply devalued the renminbi. This consolidation marked an important step forward in China's competitiveness.
Of even greater importance was the improvement in its manufacturing competence. This improvement primarily reflected reforms in China and was aided by massive inflows of FDI, which were being attracted by the reforms. According to balance-of-payments statistics, China received a total of $137 billion in FDI between 1992 and 1996.[5] No other developing country has ever had such an inflow. A consequence of FDI is that the products of an economy can rapidly become highly competitive because the foreign investor brings not only capital but also modern management techniques, up-to-date technology, and, very importantly, worldwide marketing linkages. Thus Chinese imports have stagnated while its exports have expanded massively, penetrating foreign markets and displacing exports that previously came from Southeast Asian economies and even Korea.
U.S. import statistics document this market shift.[6] For example, China's share of U.S. imports of plastic tableware rose from 11 percent in 1989 to 44 percent in 1996. The Southeast Asian (SEA) share fell from 60 percent to 25 percent. The comparable numbers for the same years for U.S. imports of lamps and fixtures show China's share rising from 5 percent to 53 percent and SEA's share dropping from 61 percent to 16 percent. The situation is similar for suitcases and wallets: China's share rose from 26 percent to 47 percent, and SEA's share declined from 47 percent to 14 percent. Notice that all these products are labor intensive, but anecdotal stories tell of more sophisticated products also coming from China, although it may only be the final assembly stage that China contributes.
As a matter of historical coincidence, China reached a new stage of economic development in 1997. Previously it could have been characterized as a shortage economy, in which everything that was produced could be sold (regardless of quality). That ended in 1996. Households had filled their most pressing needs and now became more selective in their purchasing. Inventories started to build up along the distribution chain. Chinese enterprises reacted to this by becoming more customer oriented. The authorities also reacted in 1997 by slowing down the growth of imports, which are still under government control. This resulted in an unanticipated current account surplus of several billions of dollars in 1997, since the large growth of exports was not expected. Although not a large number as current account surpluses go, the amount is quite unusual for a country receiving huge amounts of FDI. Thus China not only did not act as an engine of growth for the region in 1997; it actually was slowing the train.
Subsequent to the start of the Asian financial crisis, China has been an exemplary regional citizen. Some analysts had expected that China would devalue the renminbi to offset the competitive losses resulting from the depreciation of ASEAN currencies. This did not happen, and the Chinese authorities emphatically announced that they would not devalue the renminbi. China recognized that it would not gain from devaluing and could ignite an even worse crisis. Since other currencies in the region are floating, a devaluation of the renminbi (relative to the U.S. dollar) would set off another round of currency instability. Even if the market does not do it by itself, it is likely that the monetary authorities in the ASEAN countries will not permit China to improve its competitiveness relative to them. It was just such rounds of competitive devaluations that unhinged international financial markets and worsened the great depression in the 1930s.
Furthermore, China recognized that its growing trade surplus with the United States could become politically explosive. If China was seen as manipulating the surplus to even greater heights, then a protectionist response might well be forthcoming--another reason for not devaluing the renminbi. For the whole APEC region to regain financial stability, China must provide markets for others to match its growing exports. It is of particular importance for Asian countries to offset the displacement effect in third countries. The depreciation of the ASEAN currencies will help them in finding niche markets in China itself.
In addition to its responsible exchange rate management, China has provided resources to assist the MSI countries. It provided $1 billion of financial support to Thailand, $3 million to Indonesia, and resources in kind to Korea. The Asian financial crisis has given China the opportunity to learn from the experience of others. It has now been warned of the dangers inherent in the bad loans being held by Chinese banks (which have been estimated to be between 30 and 35 percent of household savings), the banks' inefficiencies, and their excessive reliance on the government. The banking system may be one with negative net worth. Nevertheless, the situation seems manageable. Its resolution is linked to reform of the Chinese state-owned enterprises (SOEs).
As was noted at the April 15, 1998, conference at the Council on Foreign Relations, the large SOEs are being reformed through internal efforts, and the small SOEs are being left to fend for themselves in the market. Taken together, the SOEs are doing reasonably well, and provide 80 percent of the government's tax revenues. Nevertheless, it is recognized that widespread discharging of workers by the SOEs--if that should be required--could lead to social unrest.
China may well be receiving indirect benefits from the Asian financial crisis. Its responsible and cooperative behavior in the Asian financial crisis may help its membership application to the WTO. Its stature has clearly risen in the region, and its new prime minister, Zhu Rongji, is greatly respected.
It is now clear that Japan went into a policy-induced recession beginning in May 1997, when it attempted to correct a massive budget deficit through reduced government expenditures, increased social charges, and much higher income and value-added taxes. As a result of the ensuing economic downturn, Japanese imports stagnated. Indeed, Japanese economic performance has been disappointing during the entire decade of the 1990s. This poor performance resulted from Japan's earlier failure to deal properly with the collapse of its financial bubble.
In the early years of the 1990s, the stagnation of the real economy did not prevent Japanese imports from rising. This was because the yen was itself appreciating in the foreign exchange market and Japan was in the process of liberalizing its import barriers. Both forces abated or went into reverse in 1997. The yen depreciated significantly relative to the U.S. dollar, and given the large size of the Japanese economy relative to the rest of Asia, its enhanced competitiveness plus the absence of market growth put tremendous pressure on the balance of payments of the whole region. Thus Japan was a second engine of growth in Asia that was moving in reverse.
Japan was strongly urged by other countries to stimulate its economy to overcome its recession, speed up the deregulation of the country, and thereby help the region regain financial stability. No one doubts that the Japanese authorities desire a return to economic prosperity, but the urgency being felt by them seems to be less pressing than in other countries. Japan was urged to inject a massive fiscal stimulus into its economy, even though its budget deficit was already large and would obviously become larger. Fiscal policy was seen as the only alternative since Japan had already eased monetary policy seemingly as much as possible (a reason for the weak yen) and the country may be in a liquidity trap. Japan is criticized for not providing a permanent tax cut for its households and businesses.
The situation was appraised somewhat differently in Japan. A very considerable fiscal stimulus has been announced and is being implemented. It is directed mainly to the expenditure side and includes assisted lending as well as direct expenditures, but it does not include permanent tax cuts. As the Japanese see it, permanent tax cuts would only add to savings, not to household expenditures. Furthermore, they would undermine the government's commitment to restore balance to the budget. Japan faces a rapidly aging population and feels that it must correct its budget deficit soon, or the deficit will get out of control when the inevitable pressure arrives for more government expenditures. Japan is in an unusual and unfamiliar situation in that it is being forced to be the economic policy leader in dealing with an aging population. It is understandable that the Japanese are cautious in trying to find the proper response to this challenge.
Japan can be praised for its direct response to the Asian financial crisis. It has contributed importantly to easing the Asian liquidity shortage. It has made direct financing available to Asian countries, and it has strongly supported the IMF. Japan has also suggested a new lending facility for the region, but this idea was not supported by the United States, which prevented immediate action on it. Japan is the largest lender to the area. Japanese banks have rescheduled debts despite their own difficult situation. Indeed, current efforts at financial reform in Japan could cause more difficulty for Japanese financial firms in the short run before benefits are captured. Japanese nonfinancial companies already have a large stake in the region and are making efforts to increase it. In particular, they are pushing additional joint ventures.
More could be done to stabilize the yen/dollar exchange rate, whose volatility impacts negatively on Asia, but this requires cooperation from many countries. The yen could play a larger role in Asia but its role has been limited by a lack of transparency and efficiency in Japanese financial markets. Japanese analysts are aware of the dangers to the region that could come from a failure to deal adequately with the Asian financial crisis. They no doubt would cooperate with all efforts to manage it properly.
Countries in Asia are more alike in their patterns of economic success than they turned out to be in their recipes for economic crisis. The Asian model of industrial catch-up contains certain common elements that became the fundamentals for evaluating a country's performance. These include a societal commitment to grow; thus GDP growth became the most important sign of success. GDP growth was made possible by high savings rates and correspondingly high investment rates in both people (through education and training) and physical capital. In almost all cases, governments were very intrusive in guiding the growth process. They followed market-friendly policies that gave emphasis to stability--containing inflation is another fundamental indicator of success--and to outward orientation. Being able to compete for world markets for manufactures is critical to the model. Measured by these fundamentals, the MSIs were not in bad shape in 1997. Indeed, Indonesia looked quite strong.
The Asian model, however, ignored other characteristics of an economy as not being fundamental. This inattention included a disregard for a system of soundly based private financial intermediaries with an effective prudential oversight capacity in government. Also, little concern was paid to corporate governance and to whether stockholders' interests were given proper attention. In some cases, not enough attention was given to effective competition in the home market. Most importantly, however, the institutions of government were not properly evaluated as to whether they could evolve as the economy grew. Success was only measured by whether government policy could react promptly and effectively to a shock, not by whether the decision-making process was sound. Thus public debates over economic policy have been rare, and government decisions are usually made behind a screen of secrecy.
The growth records for the MSIs and other nations is shown in table 1. The circumstances of Thailand, Indonesia, and Korea were quite different in 1997, even though all clearly belong in the MSI category. It is quite probable that neither Indonesia nor Korea would have had an exchange rate crisis in 1997 if the debacle had not been set off by Thailand.
The crisis in Thailand was slow in building. It was like the opening of a combination lock: It could not start until all the tumblers were lined up--including technical, foreign debt, financial fragility, and political conditions.
From an economic point of view, Thailand had been a very successful country for many years as demonstrated by its high real growth rate (see table 1). It is important to keep in mind, however, that Thailand's political system had some distance to go to reach the stage of mature democracy. A semblance of democratic institutions was established in 1979. Significant improvements were made in 1988 when the Parliament began to have influence. Elections at times were instrumental in changing prime ministers, but political change also took place through a series of bloodless military coups--the last successful one was as recent as 1991. (The 1992 coup was withdrawn.) Thus Thailand should be considered a democracy in transition.
The Exchange Rate
In 1984, Thailand established a basket pegging system for the baht, but in reality the currency was pegged to the nominal value of the U.S. dollar. In recent years, up to the very moment of the baht's collapse on July 2, 1997, the rare deviation from 25 baht per dollar was measured in only tenths of a baht. What were the perceived benefits of the peg? The technocrats in the central bank (and in the ministry of finance to which the Thai constitution makes it subservient) sought to maintain financial stability, and the peg was the anchor of that strategy. The peg was the club in the closet that disciplined the military before 1992 and the civilian politicians subsequently to steer them away from their profligate inclinations.
As demonstrated by the experience of Chile and other countries, using the exchange rate as a monetary anchor carries great risk. The exchange rate is the most important single price in an economy. Keeping it fixed requires all other prices in the economy to be flexible in both directions if the economy is to have sufficient ability to adjust to shocks to its international competitiveness. By implication, all other economic objectives are made secondary to exchange rate stability.[7] Through the peg, it was hoped that foreign investors would ignore exchange rate risk and invest in Thailand. Private economic agents in Thailand, however, were also taught to ignore exchange rate risk--a form of moral hazard.
The system worked admirably as long as the technocrats retained control of macroeconomic policy and the U.S. dollar depreciated against other major currencies--especially the Japanese yen. Both conditions came to an end. The dollar reached its nadir against the yen in March 1994 and then staged a strong recovery. By the end of June 1997, the yen had depreciated by half relative to its peak value. The Thai baht appreciated along with the dollar. There was also some real baht appreciation taking place as Thailand's inflation rate was somewhat greater than that of the United States, which was not reflected in the nominal exchange rate between the two currencies (see table 2). Thus the first tumbler was put in place--the baht became overvalued.
Some confirming evidence of the baht's overvaluation can be seen in the record of Thailand's imbalance on current account as shown in table 3. The Thai CAD/GDP ratio began the 1990s at over 9 percent. It was gradually reduced (despite still rapid growth) to about 5 percent in 1993 and into 1994, and then began to rise again to over 8 percent in 1995-97. Both the overvaluation of the baht and the Chinese competition factor were at work in its rapid rise. Great concern over competitiveness was expressed when it was reported that Thai exports did not rise in value in 1996. This was the first of several focusing events.
The Bank of Thailand (BOT) was misled into thinking that it had adequate international reserves to withstand a currency run because it had foreign exchange equal in value to between six and nine months of imports. This conventional way of measuring reserve adequacy is flawed and misleading once controls are lifted from international capital movements. It is not paying for imports that strains the system but rather countering short-term capital outflows. Import coverage ratios are still calculated because there is no theoretical way to measure adequate protection from a capital flight, since the whole of the existing money supply as well as any new money created within the banking system could flee.
There were three distinct speculative attacks against the baht before the BOT finally threw in the towel. These occurred in November 1996 and in February and May 1997. It is interesting to note that the baht hit a 14-year high in offshore trading on June 17, 1997--just two weeks before the float. What a costly short-run victory against speculators!
The amount of intervention required by the BOT to sustain the peg was not apparent from reported data. The BOT had been accumulating foreign exchange through the second quarter of 1996, and they totaled more than $38 billion.[8] Reserves were reported to have ebbed slightly by the end of 1996 and a bit more by the end of June 1997, but the reported total was still over $31 billion. This was clearly not representative of the resources used to support the baht. Either because it was more effective, or to hide it from the public, most intervention was done in the forward market. Forward commitments to deliver dollars were more than $23 billion and rising. Essentially, the BOT used up all of Thailand's reserves in the vain attempt to sustain the peg.
With hindsight, it is clear that Thailand would have been much better served if it had severed its strong dollar peg in mid-1994. The economy would have been better off, and the crisis could possibly have been prevented if the peg had been cut as late as the early months of 1997, when it became abundantly clear that Thailand was suffering competitiveness problems. The peg was not cut probably for political reasons.
Short-Term Foreign Debts
After 1987, the Thai government undertook significant liberalization of the financial system. It endorsed globalization as a goal and wanted to add flexibility to the financial system. This was being done so that Thailand could successfully complete and survive in the rapidly changing international environment.
Many Thais sensed an opportunity to become a subregional financial center. With the takeover of Hong Kong's sovereignty by China in the offing and its expected weakening of Hong Kong's external financial prowess, Thais mused that Bangkok could take over part of the financial entrepôt business even in competition with Singapore. They envisioned a region that included the former Indochina countries, since all of them were still financially backward but moving toward market economies, and eventually Myanmar as well. The government saw a subregional financial center with Bangkok at its core as a way to reinforce political and security cooperation.
In March 1993, Thailand established the Bangkok International Banking Facilities (BIBF) for the purpose of developing Thailand into a regional financial center. Tax privileges were created for cross-currency trading and lines of co-financing credit, and some requirements, like minimum amounts for lending to Thai borrowers, were established. Although it was expected that much of the business would involve attracting foreign savings to lend to foreigners (the out-out business), in reality the BIBF facilitated lending denominated in foreign currency by foreigners to Thai firms, with banks in the facility acting as intermediaries (the out-in business).[9] The exact role of the banks is important because financial institutions are required to hedge most of their foreign borrowings, but nonfinancial firms are not and did not.
The amount of lending facilitated by the BIBF went from zero to $31.2 billion by the end of 1996. This is estimated to be about half of the total private foreign debt of $63 billion, which was equal to about one-third of Thailand's GDP in 1996. Thus the second tumbler was put in place.
Transactions through the BIBF were attractive to both lenders and borrowers. Foreign lenders could contract in foreign currency for the short term and earn a margin over LIBOR.[10] Borrowers loved the BIBF because they could get funds at from 4 percent to 6 percent lower interest rates than from domestic sources. Their faith in the peg led them to ignore the exchange rate risk involved. Much of the borrowing was used to expand capital-intensive projects in the chemical, petroleum, and construction sectors. Borrowers believed that they could continually roll over their debts, and thus they also ignored the mismatched duration risk.
The resources obtained through the BIBF helped fuel Thai growth and contributed to inflation. In particular, it restarted the property boom that had showed evidence of topping off in early 1994. It also took over the financing of Thailand's current account deficit from FDI and other long-term portfolio inflows that had been previously relied upon, as shown in table 4. By mid-1995, the Thai monetary authorities became sufficiently concerned that they began tightening monetary policy to dampen the boom, but they were prevented from doing so effectively because of the fragility of the domestic financial institutions and by political interference.
Financial Fragility
Entrepreneurship in Thailand is a family affair. In order to avoid giving up control, Thai firms financed their growth by borrowing from banks rather than by expanding equity. This was true even of publicly traded firms including banks. The debt/equity ratio for nonfinancial firms increased as the economy expanded. By the end of 1996, debt on average was twice as large as equity for listed nonfinancial firms. Most lending was based on collateral, and land was the favorite asset to pledge because it was rising rapidly in price, providing support for even more borrowing.
Since Thailand issued very few new banking charters, a growing share of the borrowed funds was being provided by finance companies. Finance companies came into existence even before the legislation was passed to regulate them. Prudential oversight was provided for in the legislation, but it was to be exercised by a separate section within the BOT that received little cooperation from others. Furthermore, deposits in finance companies as well as in commercial banks had no explicit deposit insurance. Because finance companies were barred from issuing checking accounts, they had to offer higher deposit interest rates to savers to compensate them for their longer-term deposits. Finance companies could not offset their higher costs through efficiency, since they were permitted only one branch. Thus they had to charge higher interest rates on their loans, which became attractive only to high-risk borrowers--another example of adverse risk selection that affected countries like Chile.
From 1990 to 1996, the share of total credits provided by finance companies increased from 15 percent to 20 percent. Much of this credit was fed into the property market and to borrowers who were investing in the stock market. Some of the most aggressive lending was being done by companies such as Finance One. Thus the financial system was becoming more fragile and vulnerable to monetary shocks. The third tumbler was put in place.
As time passed, the troubles of banks and finance companies began to surface. In 1994, concern grew over the mid-sized Bangkok Bank of Commerce (BBC). After carefully inspecting the BBC, the central bank tried to take over its management and sit on its board but was outvoted by stockholders. The central bank submitted a brief to the attorney general's office seeking criminal indictments against some former BBC officers for questionable lending practices by the BBC, but because of delays (there were rumors of friendly relations between the officers of the BBC and the BOT governor) the statute of limitations prevented any prosecutions. Parliamentary debates in 1996 informed the public that the BBC had been making politically motivated loans. This led to a run on the bank that forced the Financial Institution Development Fund (FIDF) of the central bank to inject $7 billion to keep it open.
The inevitable collapse of the property boom in 1996 created widespread fear over the viability of finance companies The high-flying Finance One was among the first to be embarrassed and was forced to suspend operations. In March 1997, the central bank announced that 10 finance companies had to raise more capital within 60 days, but they were permitted to remain open in the interim. This generated runs on these companies and on other financial firms as well as on smaller banks. Their embarrassment was relieved by further loans from the FIDF. Finally, on June 16 finance companies were suspended and informed they had to recapitalize or merge with others. As firms were suspended, senior officials would announce that all deposits would be guaranteed. Meanwhile the drain on the FIDF forced the central bank to lend it money, which led to an explosive injection of high-powered money into the monetary system. No wonder both domestic and foreign investors lost confidence in the baht.
Political Uncertainty
While the military controlled the government, the public treasury was seen as a source of resources for military leaders and their friends. They were prepared to leave macroeconomic policy in the hands of the technocrats in the ministry of finance and the BOT--although they were often at odds with them--because they recognized that Thailand needed rapid economic growth, which would help fill the treasury. Decisions of how to allocate some of the public moneys, however, were what the military was most concerned about. Politicians were most interested in the sectoral ministries of agriculture, industry, commerce, and communications because those ministries had the greatest potential for corruption.
When the 1992 military coup was withdrawn (through the personal intervention of the King), Thailand's parliament began to exert political power, and the country entered upon a broader transition toward democracy. Civilian politicians had learned their lessons from the previous regime and took over the critical points for graft and corruption. The system was entirely driven by money. Elected politicians needed patronage. Votes were bought in rural areas through promises of government projects in the regions (with strong support from the rural elites that controlled the construction companies) and with direct payments. The peasants enjoyed this system, thinking the more elections the better. The urban population of Bangkok, however, became increasing cynical, and political participation ebbed.
Political parties honed their strategic skills to concentrate their election spending on winning just enough seats to command the ministries they wanted at minimum cost. The result was a series of weak coalition governments. The system offered no incentives for any party to devise coherent policies for the country. Even parties that campaigned for political reform were part of the money-driven system.[11] Some businessmen were attracted to politics just to promote their own business interests.
The technocrats in the bureaucracy saw their power decline with the advent of democracy. In particular, the BOT, which had been viewed as incorruptible and exercised the ultimate in moral authority, began to be politicized in subtle and not so subtle ways. Much of its moral authority was centered in the person of its governor, who was appointed for an indefinite term and had the support of the best foreign-trained staff in the country. As a result, the governor exercised substantial power over monetary policy, although he served only at the pleasure of the minister of finance (MOF).
It was inevitable that the public's awe of the central bank would decline as more people received technical training, both at home and abroad, and technical expertise became dispersed throughout the country. Furthermore, the power of the governor became compromised as the minister of finance started to interfere in monetary decisions. Already in the 1980s, two central bank governors were dismissed by the minister of finance. The BBC affair was the final straw that broke the central bank's image of competency and incorruptibility.
The most politicized monetary decision concerned the exchange value of the currency. Two devaluations occurred in the 1980s. They occasioned great political turmoil because so many powerful domestic interests were hurt by them. The losers included the military, the foreign-currency debtors (whose numbers increased greatly in the mid-1990s), consumers of traded goods, especially imported luxury goods, and assemblers and domestic users of imported materials that were consumed at home (including petroleum). The natural allies of devaluation were politically weak. Thai farmers were not powerful, as only rural elites commanded attention. Moreover, exporters of manufactured products were either themselves debtors in foreign currency (making them ambivalent toward devaluation) or subsidiaries of foreign firms that were outside the political system. The central bank learned that it could avoid political trouble if the exchange rate was fixed to the dollar.
Thai politics became unusually unsettled when the election of 1995 resulted in the establishment of the Banharn government. The new government had little support and was viewed as incapable of governing. It was seen also as being corrupt and earned the nickname "the mobile ATM." The Banharn government lasted only one year. The 1996 election brought General Chavalit and the New Aspiration Party (NAP) to power. It also was not expected to last long because the NAP had campaigned on a platform of constitutional reform. In the meantime, Thailand's external economic circumstances were deteriorating, but political uncertainty prevented the difficult decision to devalue the currency. The minister of finance left the government in June 1997, just weeks before the crisis began. Thus the final tumbler fell in place for a crisis. Only market forces could change the exchange rate, and they would not be permitted to work until all other avenues were exhausted.
The Rescue
Immediately upon floating the baht on July 2, the central bank contacted the IMF for advice.[12] The IMF sent a team at once to Bangkok, and it found a very receptive audience among the technocrats in the central bank. On August 5, the Thai government announced that it had an agreement with the IMF along lines that the Thai technocrats approved. The agreement included a $15 billion line of credit. The conditions attached to the loan included limiting the bank's ability to inject liquidity into the financial system, raising the value-added tax, suspending 42 additional finance companies, tightening the classification of nonperforming loans, and disclosing the size of official reserves every two weeks. The new governor of the central bank announced that the debts and deposits of the suspended finance companies would be guaranteed. A $16.7 billion rescue package was approved by the IMF on August 21, 1997.
Even though the agreement was interpreted as giving the IMF control over economic decision-making for Thailand, it received wide approval in the country because the government was viewed as incapable of doing the job itself. The IMF package was a major step toward ending the crisis. Once the baht was floated, the market corrected the overvaluation, and the IMF package (along with loans from individual countries) dealt with the foreign short-term debt problem. This left only the factor of political uncertainty to be addressed, and it was handled through constitutional reform. Constitutional reform went against the political interests of the members of parliament because it would reduce their power. Nevertheless, they endorsed the new constitution that was drafted by an independent group to resolve the crisis. During the process, when the determination to enact reform seemed to waver, the baht dropped in the foreign exchange market. The market on occasion can discipline.
The Outlook
Some progress has been made, but much remains to be done. The baht seems to have been stabilized in the foreign exchange market at about 38 baht per dollar. The two largest Thai banks were able to raise additional capital, and some FDI is being attracted to other banks to help ease the financial fragility problem. The matter of excess and nonperforming domestic debt still needs to be resolved. A bankruptcy process that works is an essential requirement for this to happen. Some remaining financial institutions need to be recapitalized. The BOT needs to be reformed, especially its prudential oversight activities. Most of all, the machinery of government for devising and implementing sound economic policy must be shown to work. It will take some time for confidence to be restored, but a start has been made.
On the eve of the outbreak of the Asian financial crisis, Indonesians could well have been celebrating their economic success. They had some of the best economic fundamentals in Asia. Growth had been accelerating and remaining at high levels, and inflation was being increasingly contained. Indonesia was complimented in both the PEO Annual Forecast for 1997/98 and the World Bank's Economic Outlook of May 1997. The economic results for the first half of 1997 were at least as good as those rosy forecasts had predicted. Nevertheless, Indonesia caught a most virulent and dangerous strain of the Asian flu, and the virus shook the very roots of the Suharto government and eventually led to its downfall. Unlike the situation in Thailand, most of the critical events and decisions came subsequent to July 2, 1997, rather than before it. The real problems in Indonesia appeared as Indonesians attempted crisis management.
Indonesia suffers from the same structural weaknesses as other Asian model countries, and its political institutions were in much worse shape than theirs. Until May 1998, Indonesia had had only two political leaders since independence, and the transition between the two was marked by violence. Indeed, two facets of Indonesia's experience in the mid-1960s may still be influencing the present. Many adult Indonesians suffered through the hyperinflation of those years. Thus they are quick to protect financial assets in any way they can, and they try to convert money into real goods at the first sign of inflation. Also, most Indonesians put great weight on maintaining political stability. The turmoil of the earlier transition is not something that any Indonesian over the age of 35, and most especially the generals in the army, would want to repeat. Another factor to be noted is the prolonged drought--attributed in part to El Niño--that Indonesia has suffered, which has cut sharply into agricultural production and contributed to forest fires.
The Exchange Rate
The Indonesian rupiah was not rigorously pegged to the dollar. Instead, the rupiah was permitted to depreciate in what appeared to be a timely and orderly manner, and it was not considered to be overvalued. The monetary authorities defined a band of permitted fluctuations that marked a path of depreciation similar to the system employed in Latin America. The width of the band was changed frequently. It was as narrow as 4 percent in 1995 but had already been raised to 8 percent by the start of the crisis. After other ASEAN currencies began their rapid descent in value, however, this pace of depreciation proved inadequate. In response, the Bank of Indonesia (BOI) widened the band to 12 percent on July 11.[13] Pressure on the rupiah continued to build, however, and the currency depreciated 7 percent on July 21 alone. It became clear that a band-system could not be enforced, and on August 14 the rupiah was floated. It fell 6 percent to a record low against the U.S. dollar on that day. Nevertheless, the Indonesian monetary authorities seemed to be on top of the situation and to understand its dynamics. During the early months of the Asian financial crisis, the BOI was receiving compliments from abroad.
It is rather hard to find confirming evidence that the rupiah was overvalued in 1997. Although it is true that the current account deficit relative to GDP did rise from less than 2 percent in 1993-94 to almost 4 percent in 1995-96, the deficit was financed entirely with long-term capital inflow. FDI alone made up more than half of the total, but that amount was down from about 70 percent in 1992-93. There was some concern over the growth of exports, since the rate of expansion had been slowing, but exports were still expected to record a double-digit expansion. Nevertheless, some analysts were expecting a competitiveness problem to develop, as most investment was being directed to serve the local market.[14]
The rupiah traded at 2,431 per U.S. dollar in June 1997. After it began to float, the daily variance increased considerably, but there was hope that it would not cross the psychologically important 3,000 level. When this did occur in early October, it occasioned heightened activity. As events unfolded, the early depreciation was relatively minor compared to what was to follow in December, January, and May 1998.
Short-Term Foreign Debt
As part of the reform effort that began in 1986, Indonesia freed most international capital movements. If Indonesian firms could find a willing lender, they were free to borrow in foreign currency for either the short or long term and on either a hedged or unhedged basis. They were also free to invest abroad if they so chose. This was seen as a way to discipline domestic policy. If monetary policy became too easy, then capital would flow out of the country and the exchange rate could not be held within the band. Thus extremes of monetary policy were seen to be limited by an external governor.
In fact, it is hard to make the case that Indonesia had excess short-term foreign debt. According to the BOI, private short-term debt to foreigners (both financial and nonfinancial) at the end of 1997 amounted to only $9.2 billion out of a total short-term foreign debt of $20.1 billion.[15] Also, Indonesia was accumulating foreign exchange reserves through the second quarter of 1997 that reached $21.1 billion. A measurement of the ratio of M domestic money supply to foreign reserves, an indication of the degree of protection against a domestic capital flight, signaled nothing unusual--the figure of 6.3 was high compared with other ASEAN countries but similar to what was recorded in Indonesia throughout the 1990s.[16]
Long-term foreign debt of all kinds was $119.8 billion, confirming the observation that most capital inflow into Indonesia has been of the long-term variety. Whether the total foreign debt burden of the country was excessive is not an easy judgment to make. It requires an estimate comparing the medium- and long-term potential growth path of output and exports with the stream of service payments that must be made in the future. Indonesia's foreign-debt-to-export ratio was only about half that of the United States.
Financial Fragility
Indonesia's financial liberalization, which began in 1983 and speeded up after 1988, led to the chartering of numerous banks and other financial institutions with minimum eligibility requirements. Indonesia had a plethora of banks of many varieties, including many foreign and joint-venture banks. Of particular importance was the fact that by the mid-1990s every large Indonesian group had an in-house bank. Although branches were established throughout the country, they were headquartered in Jakarta and under central control. A great deal of domestic liquidity was created through these institutions. Much of the credit was used to finance long-term projects, while the banks obtained resources through short-term instruments. The potential for self-dealing that comes from such a banking structure became a reality as owners, employees, and borrowers with connections drained the resources of their respective banks.[17]
The government authorities who were responsible for prudential oversight were woefully unprepared for the task. Both the ministry of finance and the BOI did not give prudential oversight a very high priority. Given the number and value of transactions occurring in the private banking system, the amount of resources devoted by the government to prudential oversight were minuscule.
As long as the real economy continued to grow rapidly and the M2 money supply was permitted to expand at twice the rate of real output, the vulnerability of the banking system remained small. There was evidence of an asset price bubble, but Indonesia was not unusual in that regard. When the Asian financial crisis hit, however, the problem mushroomed. Interest rates climbed especially sharply when support for the rupiah was removed in August, adding to the domestic financial squeeze and calling into question the viability of many banks.
Political Uncertainty and the Rescue
Although Indonesia has democratic institutions, they exist only in form. The government has been authoritarian, with power centered in the hands of the president who has been supported mainly by the army. This system brought 30 years of political stability and growing prosperity. All segments of the population have benefited from economic growth. A middle class has been created, and abject poverty has been all but eliminated. Nevertheless, some people benefited more than others. The ethnic Chinese minority (benefiting from the protection of President Suharto) owned most of the country's wealth. Being close to President Suharto provided obvious economic advantages. Indonesia became known as a "high-cost economy," a euphemism for cronyism, corruption, and nepotism (the oft referred to "CCN" of Indonesia). None of this is new, and corruption may even have decreased by the 1990s, although possibly it became more concentrated and high profile, involving the president's family.
The weakness of the Indonesian political system stemmed from the absence of reliable government institutions that could be counted on to devise effective policy responses to challenges. The weakness was not critical as long as President Suharto was in control and was prepared to let anointed technocrats make crucial economic decisions. In the past, these technocrats were protected from political interference by the president. Such a system, however, is bound to be undermined by its very success. Economic progress thickens the middle classes, who demand more participation in the decisions that affect their lives.[18] People become emboldened and less easily cowed. Powerful economic interests close to the president were taking a hand in revising economic policy, as the policy vacillations in Indonesia as the Asian financial crisis deepened reflected.
The ongoing Asian financial crisis challenged the centralized crisis management capability of the Indonesian government, and it was not up to the task. There appeared to be little coherence in what was being done. At the end of August, selective currency controls were imposed, but on September 1, as part of the government's first rescue package, the 49 percent cap on foreign participation in new initial public offerings (IPOs) was lifted. Thus it was unclear whether Indonesia wanted to be more integrated in global financial markets or more separated from them. A second government package was announced on September 15 and included such conventional items as postponing infrastructure projects and trimming the budget, but the Bank of Indonesia (BOI) was simultaneously cutting interest rates to ease its tight monetary stance--as requested by President Suharto himself. The market was little impressed by all this, especially since news of riots in eastern Indonesia (mainly aimed at Chinese shopkeepers) came at the same time.
On October 8, the government sought assistance from the IMF. After several weeks of difficult negotiations--conducted behind closed doors--an agreement was reached on October 31 and announced the following day. This agreement (and the next one) was subject to much criticism by Indonesians and many foreign observers. Along with the usual conditions of tight monetary and fiscal policies, the IMF insisted that 16 banks be liquidated. Although these banks no doubt deserved to be disciplined because of their shoddy lending practices, the depositors in them (and other banks) had no explicit deposit insurance from the government. A monetary panic ensued, and within weeks a considerable amount of funds were being withdrawn from domestic banks and deposited in Indonesian branches of foreign banks. In the process, rupiah were turned into dollars despite an interest rate differential of 20 percent between deposits in the two currencies.
A political storm was created by the owners of the closed banks, and it had some impact. Several of the banks reopened under new names, including the Bank Andromed, which was partly owned by the son of the president. In addition, 15 of the large infrastructure projects that had been shelved in September were reinstated, and all had links to the presidential palace. Needless to say, the market reacted badly to these events--but worse was yet to come.
In early December, rumors began to spread concerning the health of the 76-year-old President Suharto.[19] He was not seen in public for a week, and he canceled his participation in the long-scheduled ASEAN summit meeting. Without strong leadership from the top, there was little hope that the Indonesian political system could devise and implement coherent policy. All authoritarian regimes at some point face a succession crisis. The one in Indonesia had been building slowly for several years, and now it burst into the open.
The political crisis was reflected most strongly first in the foreign exchange market and then in the streets. After a reasonably orderly retreat during November, the rupiah was trading at about 3,500 per U.S. dollar. After the early December scare, however, the market gyrated wildly and became almost disorderly. By mid-December, the rate was 6,000 rupiah per dollar. The early days of January were even worse. When the January 6, 1998, state budget was announced--and possibly misrepresented in the foreign press--the rupiah hit over 9,000 per U.S. dollar. It became an open secret that the IMF was very unhappy with the budget, as it seemed to violate the terms of the (first) IMF deal. The rupiah then pierced another psychological barrier at 10,000 to the dollar, and a dollar buying panic was in full swing.
Desperate measures were needed, and the IMF responded. Within days, a second IMF package was assembled. It was signed by the president on January 15, 1998, and, this time, made public. The package contained 50 separate commitments by the Indonesian government and was very far reaching indeed. In addition to defining the broad macro framework, it called for such things as the canceling of 12 infrastructure projects that had been in and out of the budget, the elimination of monopolies on the distribution of sugar and wheat flour, the full deregulation of domestic trade in agricultural products, and much more. Critics wondered whether any country could actually introduce such massive changes within the time frame implied by the agreement. A new high-level council to implement the agreement was formed and was to be chaired by President Suharto himself, although it was widely rumored that he had not studied the agreement before he signed it.
The market was decidedly unimpressed by the agreement, as it did not appear to be capable of implementation. Furthermore, the thinking went, if the situation required such revolutionary measures, then the government must really believe that the fundamental situation was much worse than it was saying. The rupiah not only continued to fall in value, but the pace of its fall speeded up. The market dropped 36 percent when President Suharto named his close friend Bacharuddin Jusuf Habibi (B.J.) to be the next vice president. The People's Consultative Assembly formally named President Suharto to another term in office with Habibi as vice president, but the market remained unimpressed. Furthermore, the new cabinet was packed with friends and cronies of the president rather than with people known for their competence. The rupiah sank to an unbelievable value of 17,000 to the dollar on January 22, 1998.
The market finally began to reverse--whether from sheer exhaustion or the cashing in by speculators is hard to tell. The announcement of new banking sector reforms on January 27 probably helped. It was about this time that the idea surfaced of creating a currency board that would rigidly peg the rupiah at 5,000 per dollar, an idea that seemed to hit a responsive cord with President Suharto (and his daughter Tutut). When financial analysts of all stripes concluded that the idea was unworkable at that juncture in Indonesia, it faded from view. Nevertheless, the 5,000 value seemed to be a kind of focal point that might define the neighborhood in which the rupiah could come to rest.
A third IMF agreement was announced on April 10, 1998, calling for a $43 billion support package, yet another set of macro targets, and significant but more narrow reforms. It also focused on 6,000 rupiah to the dollar as an equilibrium neighborhood for the exchange rate. By early May 1998, the rupiah was trading at about 8,700 per dollar, but that did not last.
The calm in the foreign exchange market was shattered when the continuing (and mainly peaceful) student demonstrations were attacked by the police on May 12 and several students were killed. This set off several days of severe rioting in which hundreds of people died. The foreign exchange market reacted immediately and pierced the 11,000 rupiah per dollar level. The Suharto family was rumored to have sent billions of dollars abroad. After eight tortuous days during which the economy ground to a halt, President Suharto and eleven members of his cabinet resigned on May 20, 1998, and B.J. Habibi was sworn in as interim president.
The Outlook
Some time must pass before the political dust can settle. Habibi has no political base of his own and is not known to be a favorite of the army, which will remain the strongest political force provided it keeps its cohesion. Elections have been promised before the end of 1999. Meanwhile, the economy is in shambles. The devaluation of the rupiah has been enormous, much greater than any other currency involved in the Asian financial crisis. Domestic inflation is soaring, and it is not known what remains of the domestic financial industry. The IMF loan has been suspended.
The crisis cannot fully end until the political regime that has succeeded President Suharto indicates it is capable of forming a coherent plan to revive the economy and begins to implement it. Obviously the Indonesian economy is in for several years of great difficulty. Nevertheless, the situation is far from hopeless. The natural resources of Indonesia are still there, including petroleum. Nature will return to normal patterns and permit an agricultural recovery. The infrastructure built up over 30 years is in place, and, most important of all, the people remain educated and respond to appropriate economic incentives. Many foreign-owned banks are present, and the economy can operate on a dollar basis for awhile. The country can recover when proper economic policies are in place and the institutions of government provide assurance that they will respond as needed. Providing such policies and assurances is the task ahead for Indonesia.
South Korea's involvement in the Asian financial crisis demonstrates why economists use two-handed arguments. On the one hand, it is unlikely that Korea would have had a foreign exchange crisis if it had not been drawn in by the contagion of the Asian flu.[20] The devaluation of the new Taiwanese dollar was the focusing event, according to this line of reasoning. On the other hand, the structural economic and political problems of Korea are great, and many analysts believed that those problems were going to create an economic crunch quite independently of the currency turmoil in Southeast Asia.[21] According to this analysis, the focusing event was the bankruptcy of the Hanbo group, which marked the unraveling of Korea Inc.[22] Both propositions are supportable.
Korea is one of the miracle stories of Asia. Korea looked to Japan as a model for economic development based on export-led growth, and Korea determined to accomplish its industrial catch-up in half the time it took Japan. With the assumption of political power by President Park Chung-Hee in the early 1960s, the government accepted responsibility for directing economic growth. The results were phenomenal. In 35 years, Korea became the eleventh largest country in the world measured by GDP. Per capita income, which had been no higher than that of the poorest countries of Africa and Asia, reached over $10,000 with reasonably equitable distribution. In recognition of its economic success, Korea was admitted to the Organization of Economic Cooperation and Development (OECD)--the exclusive club of industrial countries--as its only its second Asian member. Korean business firms grew enormously, and their products became household names around the globe.
In addition, Korea made progress in political development and is further along in the transition to full democracy than Thailand (not to mention Indonesia). Under considerable pressure from middle-class demonstrators, President Chun Doo-Hwan permitted an honest election in 1987. As a result, President Roh Tae-Woo was elected with some moral authority, and he oversaw the honest election in 1992 of President Kim Young-Sam, who became the first civilian president under the present constitution. Nevertheless, this transitional democracy has weaknesses. Party loyalties are slight but regional loyalties are fierce. With multiple parties vying in elections, no president has won an election with more than 40 percent of the popular vote. Most critically, money has played a disproportionate role in the system, making it vulnerable to corruption. (Both Presidents Chun and Roh were convicted of corruption and sent to jail.) Furthermore, the heavy hand of government in the economy has created a kind of macro moral hazard: the large business groups that consider themselves "too large to fail" and that complicated Korea's response to the Asian financial crisis.[23]
The structural economic problems of Korea involve nonfinancial firms, financial firms, and the labor market. The industrial structure of Korea is dominated by large family-centered groups, the chaebol. They such as supermarkets and department stores. Many fears have been voiced concerning the command not only high-profile industries such as autos and steel but also more mundane activities inadequacy of competition within the domestic market and the total disregard of the interests of nonaffiliated stockholders. The chaebol grew to their dominant position by borrowing heavily from banks--and for many years they were given a privileged position when borrowing if they would follow government direction as to what to invest in and where to sell their output.
Three manifestations of the chaebol problem have appeared in recent years. First, in response to growing global competition, major industrial firms in other countries were narrowing their focus and concentrating on core competencies. Not so the chaebol. They were continuing to diversify into unfamiliar industries that required huge new financial commitments. For example, Samsung, the world's leader in DRAMs for computers, has started an automobile business, and Hyundai, Korea's leading auto firm, wants to produce basic steel. Second, the chaebol became overleveraged, as debt grew several times as large as equity and the value of equity was exaggerated through the practice of cross-ownership of affiliated companies. The reported debt/equity ratio of the top 50 chaebol was 3.97 at the end of 1996.[24] When the Korean economy slowed its growth to a more sustainable (but still high) 7.1 percent in 1996, it all but wiped out all the profits of the corporate sector. Korea was experiencing profitless growth because of overborrowing. The most dramatic evidence came, however, when seven chaebol among the top 50 went into bankruptcy/receivership, some even before the Asian financial crisis started. Such well-known names as Hanbo, Kia, Halla, Sammi, Daenong, and Jinro were among them.
From the very start of economic planning in Korea, control over lending was considered the principle instrument of industrial policy. Under Park Chung-Hee, the existing private banks were nationalized. Although the privatization of banks started under President Chun, it was a matter of form since the government continued to name bank presidents and boards of directors. So-called policy loans dominated bank portfolios. With the excesses of the heavy chemical industry program in the 1970s and early 1980s, many of these policy loans became nonperforming, but everyone knew that they were the responsibility of the government. Korean banks reported nominal profits even though they were probably insolvent. This has had a huge impact on managing the Asian financial crisis.
Korean labor rights had been suppressed under the authoritarian regimes. When democracy came in 1987, many formerly underground labor unions surfaced. They wanted more than higher wages; they demanded economic justice for the past. Industrial relations became chaotic, and strikes were numerous. To pacify the workers, the government passed many pro-labor laws. These included limitations on a firm's ability to fire workers in the face of changing economic circumstances. Wages rose dramatically, and the flexibility of the labor market was undermined. Both became elements in the weakening of Korea's international competitiveness and its ability to adjust to the Asian financial crisis.
The Exchange Rate
Koreans have never been enamored of fixed exchange rates, although they prize financial stability. It was a rare year that their currency, the won, was not adjusted by 3 percent or 4 percent relative to the U.S. dollar and in both directions. Having a very open economy--that is large exports and imports relative to GDP--the Korean economy is very sensitive to the exchange rate. Korea focused on its international competitiveness, which required control over domestic inflation as well as an equilibrium exchange rate. Thus there were times when the won was appreciated to stem an incipient domestic inflation (including rising wages).
Managing the Korean won is a rather tricky business, given the fluctuations between the U.S. dollar and the Japanese yen. Japan is a major source of inputs into Korean manufactured products, but it is also a major competitor in world markets. The United States is Korea's largest market but is also a supplier of agricultural products and capital equipment. On balance, Korea's international competitiveness deteriorates when the dollar appreciates against the yen. This has been a factor of some importance since 1994.
Korea's competitiveness has also been affected by shifts in its terms of trade. Korea is totally dependent on imports for its supply of crude petroleum. Thus weakness in world petroleum prices has helped Korea in recent years. However, the largest single export of Korea is semiconductors, especially DRAMs. The price of DRAMs remained high during 1995 but dropped like a shot in 1996 and 1997 under the pressure of excess world supply. (Much of the new production capacity was being put in place by Korean firms both at home and abroad.) Thus another factor weakening Korea's international position appeared in 1996.
Some confirming evidence of a Korean competitiveness problem is seen in the CAD/GDP ratio. Korea recorded an unusual surplus in its current account in 1993 and then witnessed a steady deterioration. By 1996, the imbalance had reached 5 percent of GDP. Korea has not been particularly receptive to FDI and has on balance sent more FDI abroad than it has received. Although the gross amount of inflow has been rising in recent years, it is rather small relative to the current account imbalance. However, Korean equity markets have attracted foreign investors, and Korean firms have borrowed considerably abroad through long-term securities. Together these flows were sufficient to finance the current account deficit and net FDI outflow. Equity markets can be particularly fickle, and foreign funds can be withdrawn quickly. This was the case in Korea
Korea was accumulating foreign official reserves through the second quarter of 1996, reaching in excess of $36 billion, but then the market shifted. The Bank of Korea (BOK) had been slowly depreciating the won (relative to the dollar) for close to a year when the market became aware of the seriousness of the semiconductor situation. In consequence, the BOK was required to provide some support to the won to keep the pace of depreciation from accelerating excessively. To support a stronger won, domestic monetary conditions were tightened. Meanwhile, the slowing of economic growth and the won depreciation were having an impact on Korea's international trade. By May 1997, the deficit in the trade balance had been narrowed considerably.
On the eve of the Asian financial crisis, the won was trading at 888 per dollar. The Bank of Korea (BOK) considered 900 won to the dollar to be a critical psychological barrier and determined not to let that barrier be pierced, possibly because it feared that more depreciation would make it difficult for Korean firms to repay their foreign debts. (The BOK had successfully defended the won earlier in 1997.) This decision turned out to be a mistake, and the methods used by the BOK led to a dollar-buying panic. On August 19, the BOK was forced to spend $1 billion to keep the won at the 900 level, and a public pledge was made on August 21 to make sure that the market understood the BOK's intention. The BOK seemed to be winning the battle--but at the expense of drying up liquidity in the domestic market--until the Taiwanese depreciated the new Taiwanese dollars in October, and the game was lost.
After the new Taiwanese dollars depreciated (Taiwan is a direct competitor of Korea and had recently become a player in semiconductors) and after the Hong Kong dollar was challenged, powerful pressure built up on the won. It depreciated to 965 to the dollar by the end of October. The BOK, however, still fought a strong delaying action. In early November, a long-standing rule of the BOK came into play, with devastating results. The rule said that in the event the market depreciated the won by more than 2 percent in a single day, all trading would be suspended for that day.[25] In November, despite heavy intervention by the BOK (over $6 billion of reserves were expended and additional commitments were probably made in the forward market), the 2 percent limit was triggered for the first time. This traumatized all Koreans who had commitments to pay in dollars, and it also signaled to speculators that the BOK was defeated. The next day the market was closed in a matter of hours, and on the following day in seconds. At long last, the BOK threw in the towel, and on November 17 it let the won float. The ratio reached 1,163 won per dollar at the end of November and 1,695 won per dollar by the end of the year.
Short-Term Foreign Debt
Korea had been in no rush to liberalize controls over its capital market. The government itself had no need to borrow abroad, since its fiscal position was very sound, and it could not let private firms borrow abroad without weakening credit allocation as an instrument of industrial policy. Of course, pressure built up both at home and abroad to permit more market freedom.[26] A plan to decontrol financial markets was formulated and was to be implemented in an orderly fashion: Current account liberalization would occur first, then domestic financial lending would be decontrolled, and finally international lending and borrowing. The implementation of the plan was frequently delayed, however, and it was not fully implemented at the time of the Asian financial crisis.
Some ambiguity existed over the total of Korea's foreign debt. When offshore borrowing by Korean banks and overseas borrowing by overseas branches and subsidiaries of Korean banks are added to the usual calculation of foreign debt (as was done at the end of December), the total came to $157 billion. The short-term portion of this debt was $92 billion.
The pace of taking on foreign debt accelerated in recent years. Furthermore, in response to the Asian financial crisis and in recognition of the growing shortage of liquidity in domestic markets, the government eased curbs on overseas corporate borrowing on July 24, 1997. Korean corporations were even reported to be trying to unload their holdings of land to raise funds and to be in fear of a collapse of land prices. Korean firms increased their foreign borrowing massively to relieve their shortage of won and to finance their overseas expansion. Thus much of the short-term corporate debt that brought the country to the edge of default was of rather recent origin. The BOK felt that it had to make dollars available to the overseas branches of Korean banks to permit them to meet commitments in the interbank market. As a result, BOT reserves were down to about $7 billion at the end of 1997.
Financial Fragility
Korea did not have even a semblance of a modern and efficient group of domestically owned financial intermediaries at the start of the Asian financial crisis. The portfolios of large city banks were full of nonperforming and doubtful assets based on collateralized property. The smaller regional banks and the finance, insurance, and securities companies were controlled by the chaebol (who were prevented from owning city banks). Having an in-house financial firm provided a cash cow for the owning chaebol. Although the presence of foreign financial intermediaries was permitted, their operations were controlled to prevent unwanted competition with domestic firms. Not only were Korean banks several decades behind those in other countries, they seemed to be losing ground. Lending decisions were not based on a proper appraisal of the borrowers' ability to repay and were often influenced by political pressures--even though the government proclaimed that it had ended the practice of policy loans.
Proper prudential oversight was in its infancy. In previous years, oversight was usually addressed to discovering whether a bank was following the directions of the government in its lending activity. Knowing how to uncover and prevent self-dealing and the like was an unknown skill. The need to reform prudential control was recognized, but political leaders wrangled over bureaucratic issues such as which ministry should control the effort or whether a new agency was needed. The hard task of training bank examiners, improving their skills, and bringing coherence to a plethora of improper lending practices by various institutions was yet to be tackled.
As chaebols began to go bankrupt and even the finances of the strongest were called into question, the banks that were holding their paper were seriously compromised. The BOK pledged a $3.9 billion aid package to help the struggling banks on August 25 (even before the won plunged in value). As market interest rates rose with the falling won, the position of Korean firms as well as that of the banks to whom they owed money became desperate. The large amount of short-term foreign debt was particularly worrisome. Although the government could wipe out won-denominated debt with the use of public resources, it could not so easily do the same for the foreign debt.
Political Uncertainty
Since the constitution was changed in 1987, presidential elections are held every five years and a president may not be reelected. Korea's constitution has an obvious weakness. Although it provides for a strong presidential system, elections for the national assembly are not held simultaneously with presidential elections. Thus political coherence results only by accident or as a result of political maneuvering, which has been resented by the Korean people. Mo Jongryon and Chung-In Moon argue that the political gridlock that resulted from the absence of consensus in the government was the principle cause of Korea's problem.[27]
After some early success, the Kim Young-Sam government was unable to implement its promise to reform the economy. Three failures in particular marked its ineffectiveness: It could not steer a critically needed labor reform bill through the legislature; it could not resolve the issue of what to do with the bankrupt Kia Motors; and it could not implement financial reform.[28]
As fate would have it, the presidential election was set for December 18, 1997, just as the won was under its greatest pressure. As usual, there were many candidates, but this time even the government party was split between two candidates. Pre-election polls indicated that Kim Dae-Jung--the perennial outside candidate from Cholla Namdo--was leading and would be the winner with about one-third of the popular vote.
The possibility of a victory by Kim Dae-Jong created great political uncertainty. Who could his economic advisers possibly be, since none of the establishment figures supported him, and what might characterize his policy? He was known as wanting to be his own economist, and he had a long record of advocating populist measures. Also, his advanced age and a pre-election deal made with another aging politician, Kim Jong-Pil, made his exercise of the office unsure. What was certain was that he would face a legislature that was controlled by the opposition and by some people who had been his political enemies for many years. Political stalemate was clearly a weakness of Korea's transition to democracy.[29] It was certain to continue.
The final bit of uncertainty concerned the possibility of constitutional reform. The two Kims had announced that they favored a parliamentary system for Korea. Although such ideas had surfaced from time to time and received support from serious political scholars, the change would be a very great one for Korea, which has had little experience with such a system.[30] Furthermore, the proposal might have been only a strategic ploy within the context of the election and not a deeply held conviction. No one knew for sure. It is the weakness of Korean politics which Professor Ahn Byung-Joon points to as the principle reason for the crisis.[31]
The Rescue
With no other option available and with the possibility of having to default on foreign debts staring it in the face, the government on November 21, 1997, sought help from the IMF, even though the election was only three weeks away and these particular Korean policymakers would surely be out of office very soon. Tough negotiations followed, and an agreement was announced on December 5. It provided for a line of credit of $40 billion with the usual macro conditions attached as well as some requirements to clean up the institutional mess of the financial industry, including liberalization of foreign direct investment.
The market was far from impressed by this agreement. First of all, the size of the debts of the private sector was unknown, and it was not clear that the package be adequate. Second, since the private sector debts were without sovereign guarantee, there were doubts as to whether a loan to the government would really lead to repayment to foreign creditors. Finally, and most importantly, the conditions for distributing the IMF loan depended on the yet-to-be-elected government for implementation. Although endorsement was sought from the candidates, Kim Dae-Jung to refused to give his until he could study the agreement carefully. The possibility that he would demand a renegotiation was reported in the press. With hindsight, it is clear that the IMF agreement was premature. The won continued to fall in value.
As forecast, Kim Dae-Jung was elected. A series of hopeful developments followed. Kim's early pronouncements of future economic policy were quite conventional ,and he declared he would not seek vengeance against his former political enemies. He even held a very reassuring televised public town meeting with citizens in which he tried to change Koreans' views and make them more hospitable to foreigners investing in Korea. A principal economic spokesman surfaced, Governor You Jong-Keun, who is not only conventional in his views but also particularly eloquent in English (no doubt aided by his many years spent in the United States). An early success was the passage by the legislature of the long-delayed labor reform bill.
The need for a new rescue effort was obvious. The United States took the lead, and a $57 billion package was announced on December 24, 1997. This time the resources of the IMF were augmented by pledges from all the G-7 nations and the World Bank. That did the trick, and the currency markets went into reverse. Soon after came a successful negotiation to reschedule Korea's short-term foreign debt into longer-term obligations with a sovereign guarantee.[32] In addition, the Korean government successfully borrowed $10 billion in foreign markets to add to its reserves. The risk of default was ended.
Even as the crisis was building, the correction of Korea's current account imbalance was under way. By the end of 1997, the deficit had turned into a surplus. In the early months of 1998, Korea achieved record surpluses in its trade balance. Although some of this was the result of rising exports, mostly it was due to a sharp drop in imports that reflected the woeful state of the Korean economy.
Although the IMF rescue may well have resulted in the restoration of financial stability, it has still been subject to serious questioning.[33] This criticism, along with others, has put the IMF under critical examination. Much to their credit, however, Koreans do not blame others for their problems but recognize their own deficiencies.
The Outlook
Meanwhile, the Korea economy is deteriorating. Banks have stopped lending in order to restructure their balance sheets, many firms are going bankrupt, and unemployment is rising sharply. The existing social safety net for the unemployed does not cover most of those workers put out of work by small firms or new entrants into the labor force. The chances for some social unrest remain high.
The two major tasks that remain are the recapitalization of the banking system and the restructuring of the balance sheets of the chaebol. These problems are linked.[34] The entire Korean economy is overleveraged, and its correction will require both an expansion of equity and a shrinking of debt. New government regulations require the chaebol to reduce their debt/equity ratio and assess tax penalties for noncompliance.
It is unlikely that the chaebols' operating profits will permit them to grow out of their problem within a reasonable time frame. New equity must be found at home and abroad. The government is trying to encourage more FDI, but the results have not been dramatic. A possible solution is debt-for-equity swaps with the banks, but that would worsen the dilemmas of the banks. It is most likely that public resources will have to be injected at some point to solve this problem.
Forecasts of the outlook for the economy are very guarded. Successive forecasts have became more pessimistic. Nevertheless, the bottom should be hit in 1998, and some recovery will likely occur in 1999. However, it will be only be 2000 at the earliest that Korea is likely to reach its potential rate of growth.
The IMF has been involved in every phase of the Asian financial crisis: in the environment that created and triggered it, in the circumstances that in some cases exaggerated it, and in putting together the programs that resolved it. Once the Asian financial crisis started, the IMF acted quickly to try to diffuse it. It negotiated new agreements with Thailand, Indonesia, and Korea, and it reestablished its program for the Philippines. Nevertheless, the IMF has been subjected to unprecedented criticism, some of it by respected establishment figures. Four levels of criticism have surfaced:
1. The IMF is no longer needed and worsens the behavior of markets by creating moral hazard.
2. The IMF is secretive, unknowing, and its advice is often wrong.
3. The IMF is too intrusive in its dictates to sovereign governments and insists on policies that are unnecessary to restore currency stability.
4. The IMF is too contractionary in its dictates for macroeconomic policy and underweights the real economic costs resulting from them.
The most fundamental critique has been made by George Shultz, William Simon, and Walter Wriston.[35] They argue that the IMF was not created for the role it has now assumed and that since the Bretton Woods system no longer exists, the Fund is not really necessary. Furthermore, by bailing out errant countries and facilitating the repayment of loans that should not have been granted, the IMF creates moral hazard. Without the IMF, global markets would solve the problem by themselves.
As noted by Paul Krugman and others, history has demonstrated that financial markets do exaggerate and are subject to speculative bubbles that collapse. Lenders may be very careful, but financial markets are vulnerable to self-reinforcing collapses of confidence unless there is a lender of last resort.[36] Such an institution is needed to prevent a serious and unnecessary implosion of the international monetary system and a systemic meltdown. Without the IMF, in such a crisis an ad hoc consortium of countries would have to be pulled together. The consortium would neither be as timely nor as effective as the IMF. The United States acting alone could not and will not take on the task of being the world's central banker. It would not be politically acceptable at home and would be resented abroad.
Moral hazard is a problem, but how serious is it? The IMF is at the top of the heap in creating moral hazard.[37] The argument that Paul Krugman puts forth concerning the liabilities of national financial intermediaries (mainly banks) can also be made with respect to international lending. If bank liabilities are perceived to have an implicit government guarantee in the absence of strong regulation and prudential oversight, a severe moral hazard is created.
The most important task of the IMF is to safeguard the international financial system. Thus the IMF will step into an international financial crisis to restore order in the affected market and thereby restore confidence in the besieged currency and attempt to keep the crisis from spreading to other currencies.[38] Restoring a workable financial system requires relieving the extreme distress of the large banks that dominate international lending, for otherwise the system would seize up and all legitimate international transactions would be crimped. An IMF rescue effort will either directly or indirectly facilitate the repayment of loans to these banks, regardless of whether the banks embarked on irresponsible lending in the first place. The IMF program helps safeguard the system but at the expense of encouraging improper lending--thus moral hazard.[39]
But since these large banks are headquartered in the most advanced industrial countries, are they not subject to strict prudential oversight by their domestic regulators? Yes and no. Prudential oversight in some industrial countries is not conducted as it might be (notice the problems in Japan, Norway, Sweden, and Finland in recent years), but, more importantly, the task of overseeing an international operation is very complex and may be impossible if a bank is intent on hiding its riskiest activities. Bank holding companies can be set up in foreign jurisdictions, such as the Cayman Islands, with little or no regulation. Loans and deposits can be funneled through these entities and be very difficult for regulators to unravel.
Although some moral hazard may be present, its existence is not as important as Krugman and others have suggested.[40] Asset markets can become exaggerated and collapse even in the absence of moral hazard. Although banks can make mistakes, they do not love to do irresponsible lending. Banks and bank officers can and do suffer when their international portfolios are in question. Any investor who invested in the equities and debt securities of troubled Asian campaniles has lost considerably in recent years. Also, direct bank loans by foreign banks to nonfinancial firms have considerably less chance of repayment. There are serious consequences for banks if they make irresponsible loans.
It can also be argued that if implicit guarantees are present in foreign lending by banks, the benefit is not captured only by banks. The risk margin added to interest rates on lending to many countries is less than the inherent risk would dictate, and thus borrowers share in the benefit. The IMF can be construed as providing a low-cost insurance policy for the global financial system that may have the desirable effect of encouraging more lending to developing countries than would occur in its absence.
A broad based attack on the IMF has also been mounted by Jeffrey Sachs.[41] He argues that the negotiations between the IMF and crisis countries have been conducted in secret and that even the details of the agreements are often not known by the people who should be aware of them and who are certainly affected by them. Thus the IMF suffers from a democracy deficit. Moreover, the IMF staff lacks the deep knowledge of the economies that it is prescribing for and often gets the prescription wrong. Furthermore, the IMF strategy of emphasizing the deficiencies of the economy rather than its strengths is flawed if the goal is to strengthen confidence in the currency.
The IMF is critical in crisis situations because when it reaches an agreement with a country that includes policy prescriptions along with the promise of additional resources, it is essentially giving its seal of approval, which is expected to restore confidence in the threatened currency. Loan managers of foreign banks can point to an IMF program when they go to their boards of directors and their regulatory authorities for approval for continued lending to a country in difficulty. To achieve this result, the agreement must be available for study, must be substantive, and must be achievable. Without these characteristics, an IMF program may not be an instant success.
Of course, the IMF is not a free agent but a cartel of governments. The IMF cannot release the details of an agreement unless the affected government consents. Nevertheless, the agreement must be widely disseminated and supported by the government if it is to work. Little is to be gained, however, from negotiating in public, and an agreement might be stillborn if politicized prematurely.
Martin Feldstein has reinforced some of the Sachs critique but with a difference.[42] He argues that the IMF makes a mistake when it includes major structural and institutional reforms as part of its conditions for providing financial support. Instead, the IMF should have less ambitious goals that focus on balance-of-payments adjustments. The problem with structural reforms is that there may not be full agreement on their correctness--Sachs argues they are likely to be wrong--and they are not legitimately raised by the IMF because they are too intrusive into a country's sovereignty. Adverse consequences may well follow if a structural requirement essentially misdiagnoses the cause of a crisis that, in reality, may be only a temporary liquidity problem, as in Korea. Structural problems existed when the countries were still enjoying economic success, and their correction may well not be required to restore that success.
The IMF counters these arguments by noting that it must deal with the problems that led to the crisis, including structural and institutional weaknesses.[43] Of course, mistakes can be made. Some may well have occurred in the case of Indonesia. In a country without explicit insurance against loss for individual depositors, closing banks as was insisted upon by the IMF is bound to cause a financial panic. With hindsight, an alternative way of reigning in the errant banks without closing them should have been tried. Furthermore, the second IMF package for Indonesia mandated so many mandated reforms for the domestic economy that it was unreasonable. As Indonesia falls short of fully implementing the package, as surely it will even with the best of intentions--and one does not know whether its leaders will have the best intentions--then questions will continue to be raised as to whether the deal is unraveling.
Adding structural reforms to a stabilization package is desirable if the package works. A crisis is the best time to overcome political resistance to change. An Indonesian has been quoted as saying "bad times make good policy." The IMF should take on the role of foreign demandeur, but it should only ask for those reforms that are sensible, can be accomplished in reasonable time, and have a significant chance of being implemented. This means that the IMF must be guided by local views and depend only on reliable policy analysts within the country. Thus the IMF team must consult beyond its natural counterparts in the central bank and ministry of finance. In particular, it must discuss reforms with regulators. If a reform seems to be a bit of a stretch, it is probably wiser to leave it out.
Finally, the IMF has been criticized for demanding as part of its packages macroeconomic policies that are too contractionary. It is argued that its prescriptions may have fit Latin America in the 1980s, when government excesses were the root cause of the crisis, but not Asia. The "one model fits all" approach not only forces an unnecessary and painful contraction of the economy but may be counterproductive for restoring confidence in the currency. This criticism has been made about the agreements with the Philippines as well as with the MSIs.[44]
It has been the IMF's position that a sharp rise in real interest rates is necessary to attract foreign currency and restore stability to the foreign exchange market. The most important assetholder to entice is the domestic resident, who will respond as liquidity is drained from the domestic economy. With a restoration of confidence, interest rates can be reduced. This can happen rather quickly, which minimizes the damage to the real economy. If an error is made, it is better to err on the side of being too tight rather than too easy. Confidence, which will be fragile at best, could be lost all too easily if the error is made of being too easy.
Conceptually, investors respond to the risk-adjusted certain equivalent rate of return. Risk will increase and reduce the expected rate of return if a very high real interest rate throws otherwise sound companies into bankruptcy and undermines the banks that loaned to them. In a country such as Korea, which is known to be greatly overleveraged, high interest rates could have a perverse effect on confidence and will increase the pain of real economic contraction.
In the midst of a financial upset involving the depreciation of a currency, the monetary authority has no sure way of knowing exactly what is the optimal growth rate of the money supply and the optimal nominal interest rates. Although quite defensible, the real cost of being too tight must also play an important part in the calculation. What would appear to be the better strategy would be to lean toward the side of tightness but be ready to ease and provide directed injections of liquidity if otherwise sound firms appear to be on the brink of bankruptcy. Again, the local authorities must be the ones to interpret the uncertainty.
To its credit, the IMF has been flexible when it became clear that elements in its package were inappropriate or had already accomplished their goal. Upon reflection and renegotiation, the IMF has backed off requirements in the Philippines and Korea. Since these kinds of situations are constantly evolving and thus not entirely predictable, it is well that the IMF is flexible because flexibility is an essential element in restoring and sustaining financial stability.
The United States was not quick off the dime in coming to the aid of Thailand on July 2, 1997, and many Thais resented it. It should be noted, however, that the U.S. Treasury was restricted from using the resources of the Exchange Stabilization Fund to help Thailand. Congress had imposed the restriction because it did not like the use of unappropriated money to support Mexico during its 1994-95 crisis. (These restrictions expired in September 1997, in time for the Indonesian and Korean packages.)
Nor did the United States seem very cooperative when it rejected (almost with disdain) the Japanese proposal to create a new Asian lending facility to help countries in distress. The U.S. position was probably correct since the early version of the proposal made the facility independent of the IMF, and the United States did not want to weaken the authority of the IMF in any way, but a sensible counterproposal would have been much better than flat rejection.
After these early missteps, however, the United States became fully engaged and provided the only leadership aside from the IMF in resolving the crisis. In the words of Professor Ahn Byung-Joon, the United States is the leader of last resort. The United States fully recognizes the importance of the region's economic, political, and security dimensions. If there was any doubt as to which country was the leader of the global economy, the Asian financial crisis dispelled it. Importantly, the administration's support for the IMF has not wavered, even though Congress has been reluctant to enhance its resources. The United States supported and urged the IMF to include structural reforms in its bailout packages. Indeed, criticisms of the IMF have rubbed off on the United States, as it is seen in some quarters as being in control of the IMF. Although exaggerated, there is justice in the charge that the IMF has helped to achieve long-standing goals of the United States in opening markets in Asia.
With respect to the most seriously impacted countries, the United States has been generally praised for its efforts in Korea. The U.S. government's contribution to the 1997 Christmas Eve agreement was important and appreciated.
The U.S. involvement with the rescue efforts in Indonesia was both less successful and generally not well received because they backed what appears to be a flawed IMF program for that country. At several critical moments, the U.S. government made direct overtures to President Suharto to abide by the agreement but with little visible effect. President Clinton telephoned him, former Vice President Mondale was sent to Jakarta for direct pleading, and senior officials of the Treasury made representations (sometimes interpreted as threats) to shore up the wavering that was perceived on the Indonesian side. When the political crisis hit in May 1998, the United States was ambivalent between the dictator they knew and the future leader that they could not even identify. It was only at the very point of President Suharto's departure that the United States agreed his stepping down was a good thing.
The Asian financial crisis has been a two-edged sword for the U.S. economy.[45] It has sharply increased the U.S. trade deficit as exports to Asia are curtailed by lack of demand while imports from Asia are increasing. The United States is seen as the global consumer market of last resort. Leading U.S. banks have an overall exposure to the MSIs estimated at $100 billion. Although significant, that exposure is less than that of Japanese and European banks. Also, Asian tourism to places such as Hawaii and Las Vegas has suffered. Finally, the Federal Reserve has probably been constrained in tightening credit in the United States for fear of worsening the Asian situation that may be feeding an asset bubble in U.S. asset and financial markets.
However, there is the other side. As capital has been deflected from high-risk Asian markets, it has sought refuge in the United States. This has flattened the yield curve in U.S. debt markets and added to the stock market boom. With Federal Reserve approval, the economy has continued to grow above its assumed potential rate and the unemployment rate has declined below what was previously thought comfortable by the Fed. Furthermore, the United States inflation rate has been moderated by declines in the prices of internationally traded commodities and by the lower dollar-prices being offered by Asian exporters of manufactures. Moreover, the Asian financial crisis may be serving to open markets in Asia that were previously closed, such as in Korea.
Although the United States could on balance benefit from the Asian financial crisis, there is another plausible and worrisome possibility.[46] Even as things stand, the negative effects in the United States are concentrated in manufacturing and especially on American workers in manufacturing firms. If corporate profitability is undermined by the Asian financial crisis, then the asset bubble could burst accompanied by a decline in corporate real investment. A collapse of equity prices could have a wide contagion effect on consumption, commodity markets, and currencies and could spread the Asian financial crisis beyond Asia.
American nonfinancial firms operating in Asia have not had serious problems to date. Moreover, most of the U.S. firms are really global in scope and have offsetting gains in other regions. Although short-term adjustments will be made to reflect the immediate situation, there is unlikely to be any reduction in the long-term U.S. commitment to Asia. Major U.S. firms such as Hewlett-Packard and General Electric have announced major expansion plans in Asia.
The official U.S. government position as stated by Deputy Secretary of the Treasury Lawrence H. Summers emphasized the overwhelming U.S. interest in restoring financial stability to Asia.[47] The United States also strongly supported the reform efforts being made in the MSIs and the IMF's insistence in bringing them about. The United States also recognized that there is an agenda for strengthening the global financial system that has yet to be addressed.
The economic fallout from the Asian financial crisis has been disastrous for the MSIs. Economic contraction has followed the collapse of the exchange rate. Stock market values have plunged, unemployment has risen, financial and nonfinancial firms have gone bankrupt, and pessimism is almost universal. Of course there are silver linings. Economic reform has been speeded up, and some desirable political change has occurred, but much more needs to be done.
Some neighboring countries' economies have also suffered, including those of Hong Kong, Malaysia, the Philippines, and Singapore. These economies may grow 3 percent less in 1998 because of the Asian financial crisis. The impact on the world economy as a whole is probably a loss of output in 1998 of around 1 percent.
A currency crisis automatically causes a liquidity squeeze, much higher interest rates, and a credit implosion. Thus the sectors in the MSIs and nearby countries that are most likely to be hardest hit are the domestic financial service industries, especially weak banks and other undercapitalized financial intermediaries. They will have to be recapitalized and restructured. Where permitted, foreign firms will likely be enticed to invest in the ailing financial industries, and significant portions of these domestic industries might come under foreign control.
Meanwhile the bankruptcy of many nonfinancial firms and high real interest rates will curtail real domestic investment in the affected economies. Although painful, this will help correct the overcapacity in industry and the overbuilding of commercial and residential sites. In addition, consumption is being curtailed because of a drop in confidence along with the decline in real income. Intra-Asia tourism is also being hit hard. For example, Australia and New Zealand have seen almost a complete cessation of Korean tourism, which had been growing very rapidly.
Finally, the immigration of guest workers is slowing down and may be reversing. Hong Kong is seeing fewer requests for foreign domestic servants, and some of the foreign servants are returning home. Similarly, Malaysia no longer has a labor shortage and will need fewer foreign workers.
The Asian financial crisis has set off a debate as to whether liberalized global financial markets are inherently unstable.[48] The most pessimistic view is that the ease with which international capital flows inevitably leads to asset bubbles that eventually collapse. The bubbles appear in successive countries. The same investor need not make the same mistake twice, since a new groups of investors is constantly being created and enticed into speculative foreign ventures in which they will in turn be burned. Furthermore, there is a mismatch between small countries and huge global financial markets. Large international capital flows can overwhelm a small financial market and lead to misallocation of capital, real exchange rate appreciation, and eventually an exchange rate crisis.
Financial history does record a number of spectacular bubbles, but there is little evidence either that they are becoming more frequent or that they are endemic to liberalized markets where prudential rules exist and are implemented. Timely and accurate information is the counterweapon to financial excess. Technology is making real-time information available to anyone hooked up to the Internet. Even professional rating agencies might become better at what they do. Financial liberalization and technological innovation have produced new services and new products whose risks must be studied and evaluated. Rating agencies can only be relied upon if they have the capacity to undertake their evaluations and report their findings promptly. It is possible that through international diversification, markets in the future may be more stable rather than less. What is clearly true is that financial markets are constantly changing and regulators can ignore the changes at their own peril.
A valuable lesson from the Asian financial crisis is the enhanced appreciation of the importance of private financial institutions in a well-working economy. As economies grow and become more complex, increasingly the task of directing resources to their most productive uses must be performed by private financial intermediaries. To be efficient, they must be exposed to competition, including competition from abroad. However, prudential overseers must play an essential role in the financial system. Since this is a governmental function, it is imperative that regulators and inspectors be well trained and be permitted to do their job without outside distortions.
Another generally recognized lesson from the Asian financial crisis is the importance of transparency and proper accounting standards. Nothing can undermine confidence faster than the recognition that it is impossible to obtain critical data, such as the amount of short-term foreign debt or the amount of nonperforming loans, and the discovery that contingent liabilities, such as commitments in the forward foreign exchange market are not being shown on balance sheets. Without transparency and proper accounting standards, global markets are likely to mistrust the financial instruments issued and to treat them badly.
Yet another lesson is that exchange rates need to be more flexible than some countries have permitted in the past. Unless capital markets are deep and sophisticated, it is unlikely that optimal exchange rates can be determined solely by private markets, which in the case of Asia would have led to real appreciation of the very currencies that subsequently had to be devalued. The governments of developing countries need to take a hand in managing currency values but not through rigid pegging. Managing a currency range relative to a reference basket seems to be the best model to follow for now.
More attention will also have to be paid to how current account deficits are financed so as to avoid undue reliance on short-term or easily reversed financial instruments. This will require prudential oversight to make sure domestic borrowers do not get hooked on easily available foreign funds--the problem of tapping the interbank market through foreign branches is particularly worrisome. Tolerance will have to be shown for some controls imposed by developing countries to limit their exposure to volatile funds. The IMF along with others insist that financial liberalization not occur until the financial system of a country is well prepared to handle the freedom.
Economic progress requires constant change. Expanding global financial markets have been a key ingredient in the process. Innovation in the financial industry is almost unmatched in other economic activities. Nevertheless, financial innovation involves risks that may not be understood by either borrower or lender. Mishandling of these risks can lead to a financial crisis.
The Asian financial crisis demonstrates that even successful countries can be affected if they ignore the evidence of deficiencies in their financial systems. What differentiates the countries that were infected with the Asian flu from those that were not? The major differences are to be found in political systems. Policy uncertainty is an essential ingredient in triggering a financial and economic crisis, and it was present in all countries infected by the Asian financial crisis. Countries with well-working political institutions can make policy adjustments to an impending debacle, even if the problem is only discovered after another country goes into crisis.
One might note that in the past, exchange rate crises have led some countries to weaken their links with the outside world. It is unlikely, however, that the countries in Asia will react to the Asian financial crisis by turning inward. They are well aware that the economic progress they have made depended on external orientation. In fact, they are likely to speed up their liberalization efforts, as Korea as done.
Proposals to reform the global financial system will be examined in the future. Radical ideas to restrict capital flows or make them less efficient are unlikely to be adopted, nor would they be desirable. Nevertheless, a watershed may have been passed in that it is now recognized that private capital flows dominate the global financial system and that official flows are minuscule in comparison. The Asian financial crisis rescue packages put together by the IMF are unprecedently large for that institution, but they are still small relative to private capital flows. Thus there is talk of requiring a new "architecture of the international financial system."[49]
Ideas for changing the existing architecture grow out of the experience of the Asian financial crisis and recognize the dominance of private sector funds in global financial markets. They are addressed to improving information, strengthening prudential oversight, and reducing moral hazard. The most modest suggestions call for better information through more complete disclosures by governments and greater transparency on the part of the IMF. The suggestions build upon the IMF's Special Data Dissemination Standard, which would also be extended to the Bank for International Settlements (BIS).
More is involved in ideas to build stronger national financial sectors through a combination of adopting global financial standards, providing an international surveillance mechanism that would monitor compliance with the standards, and possibly adding international enforcement if the standards are ignored. The model for standard setting is the BIS's "Core Principles for Effective Bank Supervision." Similar standards could be drawn for bankruptcy regimes, accounting and disclosure requirements for listed companies, and loan classification criteria. The task of monitoring the adoption and implementation of global norms could be entrusted to the IMF, possibly in cooperation with the World Bank. If enforcement was thought necessary and desirable, then countries might limit access to their own financial markets by financial institutions that were not meeting the norm.
The most difficult and far-reaching change in architecture would be to create a mechanism so that the private sector would be made to bear more fully the consequences of its own lending decisions. The time for testing the reality of the system would be during a financial crisis, when moral hazard usually comes into play. To do this, cross-default clauses, a standard part of the boilerplate in international lending, would have to be amended and elaborated. Cross-default would have to become inoperative when a crisis was declared--say by the IMF. Refinancing of private debt would have to become an integral part of an IMF rescue package; therefore, private representatives would have to take part in the negotiations. To prevent stalemate, binding arbitration clauses most likely would have to become a standard part of lending documents.
It is unlikely that far-reaching ideas will be agreed to any time soon, but marginal and evolutionary changes are likely and would be helpful in improving global markets. A crisis makes change possible, and the Asian financial crisis is just the kind of watershed event that could energize an international reform effort.
| July 2 | Bank of Thailand permitted the baht to float in the foreign exchange market |
| July 11 | Philippine peso permitted to float |
| July 14 | Malaysian ringgit and Indonesian rupiah fall under speculative pressure |
| July 21 | The IMF prolongs its program for the Philippines |
| August 11 | The IMF and a group of Asian countries led by Japan unveil a $16 billion loan package for Thailand |
| August 14 | Bank of Indonesia allows the rupiah to float |
| October 17 | Taiwan devalues NT dollar by 15 percent |
| October 20 | Speculative pressure hits Hong Kong dollar |
| October 21-23 | Equity markets worldwide plunge |
| October 30-November. 1 | IMF package unveiled for Indonesia including closing of 11 banks |
| November 17 | Bank of Korea permits the won to float |
| First Week of December | President Suharto's health problem is rumored |
| December 5 | IMF package announced for Korea |
| December 18 | Kim Dae-Jung elected president of Korea |
| December 24 | New bailout package announced for Korea |
| January 15, 1998 | Second IMF agreement with Indonesia announced |
| April 10 | Third IMF agreement with Indonesia announced |
| May 12 | Four student demonstrators killed in Indonesia |
| May 20 | President Suharto and 11 cabinet members resign |
Lawrence B. Krause is Professor Emeritus at the Graduate School of International Relations and Pacific Studies, University of California, San Diego. He received both his Bachelor of Arts Degree and Master of Arts Degree from the University of Michigan, and his Ph.D. from Harvard University. In December 1990, he was named as the first holder of the Pacific Economic Cooperation Chair at UCSD. He is the author of many articles and books, including, Liberalization in the Process of Economic Development (Co-editor with Kim Kihwan) and Social Issues in Korea: Korean and American Perspectives (co-edited with Fun-Koo Park).
Last Updated: 5-Jun-98
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