In November 1995, speaking in Rome, Michel Camdessus noted that the world had experienced during the previous decade four major financial crises, the last of them being the Mexican crisis. He added that new, more destructive, ones would come unless the quality of the coordination of macroeconomic, financial and monetary policies was significantly improved. Since then the IMF has introduced new, more stringent transparency rules, in the hope of setting up an early warning system that would help prevent further crises.
Despite these improvements, Camdessus´s words have proved prophetic. We are now facing another financial crisis, this time originating in East Asia, which is perhaps the most serious since the breakdown of the Bretton Woods system. Not only are financial markets more closely integrated worldwide, but the very success of the East Asian countries over the past three decades has helped them gain a significant share of world trade and production. Consequently, the impact is being felt far more widely than during past crises. Indeed, for the first time, a financial crisis starting in the South has had a profound effect on capital markets in highly industrialized countries.
The duration and severity of the East Asian crisis will, undoubtedly, be a major influence on the economic performance of most countries, in both the developed and developing worlds, over the coming months. However, efforts to understand its global impact have been hampered by ambiguities. On the one hand we have been told that in today`s world globalization has dramatically increased the degree of market integration and the depth of interdependence of economies. On the other hand, we hear that the impact of the East Asian crisis on the global economy can be expected to be small.
But one should not forget that since 1990 these East Asian countries have provided the strongest stimulus for growth in the world economy and have, together with the US, become the driving force of global demand, running trade deficits with industrial countries financed in large part by private capital flows. This is probably the reason behind the increasing realism and sobriety that has lately started to dominate the views of major international organizations (such as the OECD and the IMF), which recognize that the impact of the crisis will be considerable, amounting to a very significant loss of growth world-wide.
There can be little doubt that the global ramifications of the crisis will depend on how fast the East Asian countries will be able to overcome their current difficulties. International organizations can and should act decisively to contain and reduce the destructive effects of the crisis. The priority should be to restore confidence and stability in currency and financial markets, while avoiding a deep and prolonged recession. To this end, loans should be rolled over and rescheduled (as in Korea recently) to allow countries to service them from future export earnings and not through increased external borrowing at penalizing rates. This should be combined with the provision of external liquidity to support the exchange rate and a more accommodating monetary policy which avoids unnecessary damage to the economy´s real sector, while restructuring of the financial sector is undertaken (the approach pursued by the United States Federal Reserve Board in the debt deflation of the early nineties).
Given the record so far, policy advice should be offered with a certain degree of humility and a healthy dose of pragmatism. Already some worrying, and largely unanticipated, trends have appeared in East Asia. In particular, the credit crunch seems to be so deep that, despite favourable exchange rates, firms are unable to export, as their access to trade credit has been curtailed. Thus, an important part of the improvement in the current account balances of Korea and Thailand so far seems to have been due to import cuts rather than export expansion. Over the longer horizon, however, increased exports should account for a major share of the required external adjustment.
The negative implications of the Asian crisis can already be felt in other developing regions. In Latin America, for example, the largest economy, Brazil, suffered a speculative attack which had to be fought off with a severe adjustment programme of high interest rates, budget cuts, economic contraction and sharp reduction in imports. Chile, the best performing economy from the region for over 10 years, has seen its currency depreciate by 18 per cent since October and, on account of its dependence on Asian markets (which account for 50 per cent of Chilean copper sales), its current account deficit can be expected to increase this year. Africa, whose growth has picked up in the last three years, could be severely hit if commodity prices continue to drop as a result of falls in demand and deflationary pressures
There is no doubt, however, that the biggest threat ahead is a protectionist backlash against trade liberalization. On the eve of the crisis, there was already a major imbalance in the world economy as virtually all major industrial countries (except the US) were expecting faster growth on the basis of increased exports. Before the Asian crisis, Europe was projected to generate a current account surplus of nearly US dollars 100 billion this current year and Japan was not much behind. It is unlikely that in the year of the Euro, Europe will be capable of stimulating domestic demand very much. Japan has recently taken some steps to reflate its economy, while reducing the drag on activity resulting from the weakness of its banking sector. It is far from certain, though, that the measures announced so far will be sufficient. This is worrying because a major boost to world trade and growth can only come from the three largest economic areas - the US, Japan and Europe. China can certainly help if it sticks to its intention of avoiding currency devaluation and running a trade deficit. But its contribution will probably prove limited since many East Asian exports compete directly with China.
This leaves the US in an unenviable position as the only major locomotive in the world economy and the single most important source of import demand, a sort of gigantic "black hole" that will have to swallow the rest of the world`s surplus goods. In 1997, the US trade deficit was US dollars 150 billion. It is estimated that it could explode this year to US dollars 200 billion or even as high as US dollars 300 billion in 1999. Of course, in relation to the size of its economy, this would not be much higher than the US trade deficit in the mid-eighties, on the eve of the Plaza agreement. Politically, however, it could become an extremely difficult and sensitive problem to handle. Congress has already rejected the administration´s request for "fast track" negotiating authority, when conditions, both economic and political, were much more auspicious. Now we have to allow for many more unfavourable factors: the US economy will be slowing down; corporate profits are being reduced; there are fears of a severe correction in share values on Wall Street; and a mid-term election is looming and political consensus may be harder to obtain.
We have always maintained in UNCTAD that monetary and financial instability is the principal enemy of free trade. Perhaps the single positive contribution of the East Asian crisis is that it has halted the tendency towards monetary restriction and higher interest rates in the US and Europe, and hence prevented the global deflationary gap from widening further. Let us hope that it will now spur the surplus economies to initiate domestic demand-led growth and reduce their external surplus, thus creating a favourable external environment for the growth in trade not only for the East Asian countries but developing countries everywhere.
The East Asian financial crisis has also increased awareness of the need for greater management of finance to prevent the recurrence of similar crises. There is a lot that can be done at the national level, including in particular improved prudential regulation and effective supervision of the banking system. However, the limits of such actions need to be recognized. Experience shows that, when capital inflows lead to a rapid liquidity expansion, it is not easy to prevent domestic credit from being increasingly channelled from financing safe and productive investment to risky and speculative assets. Here the problem is the absence of instruments to restrict capital inflows and contain their impact on macroeconomic and monetary conditions. Moreover, prudential regulations cannot prevent excessive non-bank private sector borrowing abroad, and in East Asia, for example, an important part of private borrowing from international banks has been by non-bank firms. Nor do international financial markets impose the right kind of discipline over private borrowers in developing countries. All too often they manifest herd-like, pro-cyclical behaviour in both making and cutting back loans. This is why governments need to be prepared to use a broad range of policy instruments, including but not restricted to prudential regulations.
Attention needs to be given to the global hiatus in institutions and instruments for handling problems associated with international capital flows. Even though financial markets are highly integrated, there is no global governance for financial transactions of the kind already in place for trade. Moreover, the present international arrangements are asymmetrical in that they aim at disciplining borrowers rather than regulating lenders. They are designed to manage rather than to prevent financial crises, and the measures used tend to be at the expense of living standards, stability and development in debtor developing countries. Furthermore, much more has still to be done to make the IMF an effective and adequately funded international lender of last resort for the provision of liquidity. And in international debtor-creditor relations, there are no rules for orderly work-outs analogous to domestic bankruptcy procedures.
These issues of system design should be considered alongside of the current initiative to extend the IMF´s jurisdiction to capital transactions. Indeed, the question has been raised whether a global regime for capital transactions can be limited to the issue of their liberalization and should not also include a broader framework of governance for economic agents in international financial markets. Moreover any amendment of the IMF´s Articles of Agreement needs to accommodate not only differing national conditions but also exigencies dictated by the rapid and continuing changes which characterise the financial sector but which cannot be fully anticipated by policy- makers and regulators. Thus the amendment should incorporate flexibility going beyond that regarding the pace of liberalization. Commitments or obligations undertaken under the amendment should not reduce the options available to national governments to protect their economies from the impact of developments in international financial markets that threaten macroeconomic stability or undermine national policy objectives.
Mr. Camdessus has rightly stressed that we should have the humility to recognize that no one can claim to perfectly understand all the complex interplay of factors that caused the East Asian crisis. Nor, would I add, could we pretend to know exactly what should be done in order to avoid the recurrence of financial crisis.
In effect, the lessons from the Latin American crisis of the eighties were not sufficient to help us anticipate and prevent the Mexican crisis of 1995. Nor were the lessons drawn from the latter and the measures taken by multilateral financial institutions in its light enough to deal with the very different kind of storm that was slowly gaining strength in Asia.
This should suggest to us that beside specific measures taken after each episode of crisis, we should perhaps ask ourselves if there is not something more systemic and global behind these frequent manifestations of financial market shortcomings. To address this question we may need not so much a major once-and-for-all conference, a sort of new Bretton Woods, but rather a patient and ordained process that would avoid ready-made and simplistic remedies and concentrate instead on setting up better institutions and instruments to handle problems of international capital flows.