Editors' Overview

Abstract

Given the existing huge academic literature on the Asian crisis, its causes and effects, a strong case needs to be made for yet another paper or another special issue devoted to the crisis. The editors of the Asian Economic Policy Review have timed this issue of the journal to coincide with the 10th anniversary of Asian crisis. Ten years provide an automatic filter for some of the many hypotheses and claims that were made during and soon after the crisis. It also enables us to judge, in retrospect, how serious the crisis was, and whether the crisis appears to have had lasting effects. As the title of this special issue, “Ten Years After the Asian Crisis: What Have We Learned or Not Learned?” indicates, the focus is not on the causes or the immediate effects of the crisis, but rather on the lessons from the Asian crisis. The editors specifically asked authors of the papers in this special issue to indicate what they thought were the lessons that had been learned (or not learned) by the stakeholder, institution, or country they were examining. An examination of figures 1–3 in Takatoshi Ito's (2007) paper that graph data on growth rates, investment rates, and the nominal exchange rates in six Asian countries – Indonesia, South Korea, Malaysia, the Philippines, Singapore, and Thailand – provides some powerful evidence based on a simple before- and after-crisis comparison. With the exception of the Philippines, average growth has fallen in all the countries. Linked to this is the fall in the average share of gross domestic product devoted to fixed capital investment. The depreciations in all these countries were not short-run temporary phenomena, so that the International Monetary Fund's (IMF) push for exchange rate flexibility was appropriate, although exchange rate overshooting in December 1997 – January 1998 is obvious. Of course, there is argument about the reasons for the fall in investment ratios (and consequent falls in growth rates). Ito suggests that the Asian countries were over-investing before the crisis, whereas in the case of Indonesia, Hal Hill and Takashi Shiraishi (2007) suggest that the investment environment relative to the rest of East Asia and to the Soeharto era has worsened, and needs to be improved. This point is echoed by Siow Yue Chia (2007) who also argues that Indonesia needs to raise its investment levels. There was a substantial degree of agreement that the conditions imposed by the IMF in relation to its assistance to Asian countries were far too harsh, and that some of the conditions were politically unreasonable. Of course, the recipient countries agreed to the conditions, so it has to be asked why the countries agreed. There were suggestions that, in the case of South Korea, the agreements were made under duress, and, in the case of Indonesia, the president may have had no intention of keeping to the agreement. Two powerful examples of the problems caused by governments and central banks trying to hide potentially damaging information are provided during the Asian crisis by the Bank of Thailand's failure to disclose large forward commitments, and the Bank of Korea's shift of its holdings of foreign reserves to deposits with the overseas branches of South Korean commercial banks. If the information is likely to leak anyway and have a significant impact on the financial markets, then the authorities should not try to hide the information in the first place. Although the Asian crisis led to political change in each of Indonesia, South Korea, and Thailand, it is no exaggeration to say that the greatest change occurred in Indonesia. Although not directly suggested by Hill and Shiraishi (2007), it is possible to argue that at some point in time a change from the Soeharto administration was inevitable, so that some of the perceived impacts of the Asian crisis in Indonesia would have occurred quite apart from the Asian crisis. The astute reader will note that the term “twin crisis” appears in quite a few papers and comments in this issue, but the term is not always used with the same meaning. For example, in Hill and Shiraishi (2007) it refers to economic and financial problems and regime collapse, whereas in Stephen Grenville (2007) it refers to banking and balance of payments problems. This section summarizes the papers presented at the Third Asian Economic Policy Review Conference held in Tokyo on October 1, 2006, the comments by the assigned discussants, and the general discussion of each paper. The papers in this issue can be collected into two groups: those focusing on key stakeholders and institutions – the IMF (Ito, 2007), policy-makers (Grenville, 2007), and the banking system (Turner, 2007); and those papers focusing on the experiences of key countries – Thailand (Sussangkarn & Vichyanond, 2007), Indonesia (Hill & Shiraishi, 2007), and South Korea (Lee & Rhee, 2007). Ito's (2007) paper is an overview of the Asian currency crisis from an historical and cross-sectional perspective. He provides a detailed comparison of the IMF's treatment of three Asian crisis countries – Thailand, Indonesia, and South Korea – with the Mexican crisis that preceded the Asian crisis, and the post-Asian crisis cases of Russia, Brazil, Turkey, and Argentina. Ito's focus is on the different conditions under which the IMF provided assistance to these eight countries, and the size and composition of the assistance packages. The comparative analysis is used to determine what the IMF learned (or did not learn) from each crisis, and the extent to which these lessons were applied to later crises. Ito suggests the similarities between Mexico and Thailand are striking – 8% current account deficits, with about 10% capital inflows, just before their respective crisis. Ito argues that the IMF, having dealt with the Mexican crisis of 1994, could not prepare and implement any mechanisms to prevent or manage a crisis before the Thai crisis in the summer of 1997. The IMF's access limits required that the support package for Mexico be put together with the USA, and the package for Thailand be put together with Japan and Asian countries. Ito criticizes the total amount of support for Thailand as being small when compared with Mexico, and with the size of forward commitments of the central bank. Ito identifies several problems with the IMF program for Indonesia, which was signed at a time of relatively strong macroeconomic conditions. First, banks closures with only limited deposit guarantees led to a run on banks and accelerated capital flight. Second, President Soeharto deviated from the IMF program. Third, there were large swings in macroeconomic policy. The signing ceremony for Indonesia's revised letter of intent provided strong symbolic evidence that the IMF was ruling Asian countries. The South Korean crisis, which caught many by surprise, is regarded by Ito as being the closest to a pure liquidity crisis as lenders refused to roll over loans to South Korean firms. To finally deal with the Korean problems, the IMF and Group of Seven had to resort to an unusual measure, jawboning commercial banks to roll over their lending. This was a switch from the lender-of-last-resort approach to the private-sector-involvement approach. In contrast to the IMF's actions taken in relation to the Asian countries and despite the view held by many economists outside the IMF that a fixed exchange rate regime is unsustainable, a fixed exchange rate (or crawling peg) was allowed to continue in the first IMF program in each of the crises of Russia, Brazil, Turkey, and Argentina. This strikes Ito as the IMF being “soft” in the post-Asian crises. Although not denying IMF assistance was beneficial, Mohamed Ariff (2007) also focuses on the conditions attached to the assistance. In particular, he is critical of the manner in which the conditions were attached. In examining and evaluating the IMF and the lessons it has learned or not learned, Ariff argues that more attention should have been paid to Malaysia, a country that chose not to seek the IMF's help. The key reasons for this choice being that Malaysia had small short-term external debt and adequate reserves. With the exception of the exchange rate system, he claims that the policies Malaysia implemented were quite similar to those undertaken in the other crisis countries. Akira Kohsaka (2007) questions the operational usefulness of a policy allocation that matches lender of last resort assistance to liquidity crises, and private sector initiative assistance to solvency crises because it will face the obvious difficulty of determining whether a country is solvent or insolvent in crisis times. Kohsaka also questions whether the IMF actually learned anything from history given that the successful Mexican case was not applied to Thailand, and that in the Russian and Argentine crises the lessons from the unsuccessful Asian cases were not applied. Jong-Wha Lee argued that Ito's approach of focusing on the role of the IMF and crisis management in each country leads to ignoring other important aspects of the crisis, for example, the question of what the key structural problems in Asian countries were. Hadi Soesastro claimed that the reason why Indonesia had to resort to the IMF was concern at the time about contagion, and the effects on the rupiah of statements made by Malaysian Prime Minister Mahathir. Hill raised the questions of whether the Asian crisis could have been prevented, and what vulnerability indicators were showing before the crisis. He guessed that the private sector behavior in Thailand with a lot of private capital exiting was quite different to Indonesia, Malaysia, and South Korea where there was no indication that the private sector would exit. Although agreeing with Ito that the Asian crisis was a crisis involving a shortage of liquidity and the idea of the Asian Monetary Fund was driven by this shortage, Shinichi Yoshikuni asked what kind of crisis would be likely now in Asia where there is in fact an excess of liquidity given the current extremely large foreign reserve holdings. Chalongphob Sussangkarn suggested that to make the paper complete, a discussion on IMF reforms was required. Atchana Waiquamdee argued that the subject of research conducted by the IMF had evolved over time, it needed to now focus on how to prevent the kind of crisis in other emerging markets in terms of capital liberalization. Ito agreed that Malaysia would be an interesting case study, especially in a comparison with Indonesia. Although acknowledging that there were structural problems and macroeconomic problems in each country, Ito emphasized that he believed that, when compared with other countries, the Asian crisis was more of a liquidity crisis than the result of structural problems. His bottom-line was that Asia was shortchanged by the IMF when compared with Mexico and the post-Asian crisis countries. The purpose of Grenville's (2007) paper is to examine how economic policy-making in the countries affected, in the Asian region and at the global level, changed as a result of the Asian crisis. Despite the size of the Asian crisis, Grenville argues that, although there were significant changes to the politics in the three countries most affected by the crisis, little change has occurred in the broad approach to economic policy. One important set of Grenville's conclusions relates to the responses that did not occur in the wake of the crisis: trade restrictions were not imposed; capital restrictions were minor and removed quickly; debts were in general honored; the Washington Consensus was broadly maintained; and banking systems were supported and restructured, rather than being allowed to fail. Although the broad tenets of the Washington Consensus, with its market-based policies, remain in place, there is now a recognition that well-functioning markets require complex institutions, rules, and procedures, and that these take time and effort to develop. At the international level, the IMF remains as the principal international crisis manager; and there is still no coordination of international economic policy-making. Changes in awareness and mindsets are where larger changes have occurred. Grenville suggests the major policy change is a much greater awareness of the vulnerabilities posed by large international capital flows. Changes in the mind-set have given sharper focus to regional exchange rate arrangements – both in the implementation of a greatly strengthened foreign-exchange swap arrangement, the Chiang Mai Initiative, which pools reserves, and the vigorous discussion about an Asian common currency. At the global level, Grenville finds that there has been considerable progress in developing the institutions that will govern and assist international capital flows. For example, the IMF has implemented various useful transparency-enhancing measures, and has undergone a major change to its thinking about international capital flows. The Asian crisis was not the first where foreign capital volatility was a major factor (Mexico in 1994 illustrated this issue), but it was the (belated) catalyst for a recognition that the volume of inflows might overwhelm small and immature financial sectors, and result in asset-price booms, upward pressure on exchange rates, and, in turn, a change in sentiment accompanied by massive and hugely damaging capital reversals. This recognition has not yet been matched by a convincing policy response. Although the IMF handled more recent crises better (larger and quicker disbursements of assistance, less and better-focused conditionality, different macro-advice), there is nothing to directly address capital-flow volatility, which is apparent even in mature transparent markets, nor to put in place better systems for resolving large-scale international default. Using recent examples of capital controls introduced in South Korea, Thailand, and China, Robert McCauley (2007) takes issue with the suggestion that East Asia has followed the consensus favoring capital account openness. In worrying about the appropriate level of foreign reserves to short-term debt, McCauley also draws attention to the need to take account offshore debts of firms and financial institutions. McCauley interprets the Asian crisis as an expression of Asian financial disintegration caused by the collapse of the Japanese asset bubble, so that measures to spur regional financial integration should receive more attention. As part of any surveillance process among Asian countries, Eiji Ogawa (2007) highlights the importance of policy discussions about exchange rates issues, macroeconomic policy, and the soundness of the financial sector. He notes that there is a large gap between surveillance and regional policy coordination because there is no commitment among the Asian monetary authorities to policy coordination. Given that regional financial cooperation can complement and supplement assistance provided by the IMF, Ogawa stresses the importance of considering the relationship between regional cooperation and IMF assistance. Although “original sin” refers to countries borrowing in foreign currencies and being vulnerable when depreciations occur, Yoshikuni raised a different type of “original sin,” namely, the vulnerability of Asian countries to exchange rate appreciations given their large asset holdings (especially, foreign reserves) in foreign currencies. While agreeing about the importance of developing bond financing, he pointed to the need for appropriate regulation and monitoring as was the case with bank financing. Both Ariff and Anwar Nasution agreed that a common currency will be a long time coming to Asia. Ariff wondered whether a common exchange rate based on a basket currencies with common weights was less far-fetched, and Nasution asked how, given the de facto dollar peg in the region, competitive devaluations could be avoided. Chia took up the issue of surveillance mechanisms in Asia and suggested that the ASEAN (Association of South-East Asian Nations) initiative and the ASEAN Plus Three initiative provided for some surveillance. She suggested that the “Asian way” where governments are reluctant to criticize their neighbours does not augur well for surveillance mechanisms. Lee thought that the paper had missed out on the reaction of private international investors that were particularly relevant for South Korea. In any discussion of the relationship between the crisis and reform, Lee argued that the issues of political change, and how governments get support for reform from the people need to be discussed. Although it was initially believed that a bond crisis was more difficult to resolve than a banking crisis because of the difficulty of bond holder meetings, Ito suggested that recent examples indicated that a bond crisis resolution may be much easier in the future. Kohsaka argued that reservations need to be added to the claims that the Washington Consensus was maintained and the IMF is still the principal international crisis manager. For the former, adequate preparation of a safety net has been highlighted, while for the later, the role of the IMF will have to be revised. Ito alluded to the problem that the Washington Consensus means different things to different people by pointing to John Williamson writing a book correcting what he believed were misperceptions about the meaning of the Consensus. Grenville agreed that we cannot be against capital controls in principle, but we need to argue about which controls will, on balance, be useful. He saw controls on foreigners borrowing in domestic currencies as being a control with little cost and large benefits. Grenville acknowledged that there were some regional arrangements, pooled reserves, or swap arrangements, in place before the crisis, but noted that none of them were invoked during the crisis. The fact that we still believe in markets and have not gone back to more divisive, intervention-prone methods of policy-making are, Grenville believed, quite consistent with the Washington Consensus. Philip Turner's (2007) starting point is that the weakness of local banking systems was a major cause of the Asian financial crisis because banks could not manage their risks well; official supervision was weak; banks were undercapitalized; and market discipline was undermined by misleading financial data provided by banks. Nearly all the statistical measures (profits, risk-adjusted capital ratios, and impaired loans) Turner provides indicate that banks have become much stronger, but the evidence also shows that much of the recent rise in bank profits is cyclical because of the combination of low interest rates and strong growth. Adjusted for this, profits would have been much lower. Given that quantitative measures can be misleading, Turner argues that it is important to make a qualitative assessment of how banking systems have changed. A worldwide effort to improve the quality of banking supervision has been stimulated by the banking crises in the emerging market countries during the 1990s. Turner sees the most significant improvement as having been in the quality of risk-based oversight by many regulators. The analyses published by official Financial Stability Reports in the region are clear evidence that central banks and supervisory agencies are more likely to act to address vulnerabilities than they were before the crisis. In addition, better public information about banks makes market discipline more effective. Finally, there is now much greater awareness of the importance of proper governance arrangements. Turner suggests that there are a number of significant shortcomings despite all these improvements. He raises the problems of policy-makers in much of Asia having trouble in grappling with a relationship-based mindset that undermines independent credit assessment; state-owned banks that are often not subject to proper governance; and banking systems in some countries are still too fragmented. In addition, the risks that Asian banks now face are different to the risks they faced before the crisis. There are three sets of risks that Turner sees as deserving particular attention. First, there are risks that are related to the very rapid expansion of lending to the personal sector. Although increased mortgage lending with properly valued collateral widens the choices available to households and helps banks diversify away from heavy reliance on corporate clients, credit risks arising from unsecured lending to households are more problematic. Second, there are interest rate risks arising from the increased bank holdings of government bonds. Third, there is exchange rate risk given that it is unclear how well banks are placed to cope with exposures that could arise from a large currency appreciation. Nasution (2007) provides some important caveats to the interpretation of Turner's results. He argues that the analysis of bank performance needs to examine more carefully the sources of bank profits, and also the structure of bank portfolios. Although risk-adjusted capital ratios of banks are impressive, the illiquidity of sovereign bonds that were used to finance the recapitalization of banks in places like Indonesia has limited banks’ ability to expand credit. Although acknowledging that improvements in corporate governance in Asia have occurred, Nasution suggests that problems with corporate governance still exist for state-owned enterprises (including banks) in both China and Indonesia. He also alludes to the strong position of foreign banks with their international networks and advanced technology that might lead to them beating out the domestic competition. Given that favorable macroeconomic conditions were viewed by Turner as having contributed to banks and banking systems becoming healthier, Mitsuhiro Fukao (2007) deals with future macroeconomic risks and the need for regulators to take these cyclical effects into account when making judgments about the health of the banking systems. Fukao examines two macroeconomic scenarios: one where investment recovers in the Asian economies as a result of low interest rates, and the other where domestic inflation leads to an appreciation of the real exchange rate. Fukao suggests that incentives need to be provided to banks to induce them to hold higher capital ratios in good times so that they have some room to move when difficult times occur. Following a spate of bank mergers in several countries, Ariff raised the problem of whether central banks have the perception that bigger is better – that is, the too-big-to-fail syndrome. Ariff suggested that smaller banks fared far better than large banks during the crisis. Colin McKenzie and Kohsaka asked whether the reason for a shift in bank lending from firms to households was a temporary lack of demand by firms wanting to borrow, or some other reasons like the appearance of other financing channels. Improvements in information disclosure are mentioned by Turner as enabling shareholders to monitor banks more effectively, but McKenzie questioned whether in the relevant countries there were investors with sufficient ability to evaluate the information. Ito raised the case of the Philippines, which was not a recipient of contagion in either the banking or currency sectors. He wondered whether there was support for the argument that because the Philippines had experienced a history of banking crises that it was better positioned than other countries. Hill suggested that the key points for the Philippines were no boom and no bust. In relation to the debate on foreign bank participation, Ito introduced the idea that opening up to foreign markets will bring foreign capital, so that the foreign banks may provide support during a crisis with capital. This idea appeared to be supported by anecdotal evidence for South Korea but was not supported by the Argentine experience. Kimie Harada raised the practical problem of how to compute risk exposures and default probabilities of banks given the lack of continuous data on the relevant variables because of mergers, consolidation, and nationalization. If the pre-crisis story was that the Asian economies were too heavily reliant on banks and not reliant enough on bond and equity markets, Hill's impression was that not much had really changed. Changyong Rhee argued that it may be a little too early to judge whether the micro-efficiency of banks had improved and their profit gains will be permanent given the enormous amount of funds injected into banks. He suggested that although the Asian crisis taught us the importance of a diversified portfolio across financial markets, South Korea has become an even more bank-dominated economy. Rhee also pointed to the many development banks and government-sponsored banks in South Korea that played an important role in revitalizing private banks, but now they have to compete with private banks, and asked whether other countries have a similar problem. Grenville raised doubts about the value of risk measures since we are interested in the tail of the distribution and we have very little information about it. In Indonesia, Grenville claimed that state-owned banks have more or less the same market share they have always had, they have not solved any of their problems, and with margins of 10% there are problems of efficiency. He also argued that relationship lending was perhaps not as bad as it looks if you lend to people you know and trust. If you yourself are the only person you trust, then you lend to yourself. Sussangkarn suggested that a discussion of the political economy of the issues, the relationships between banks, supervisors, and politicians, is a key issue. In Thailand, there is still a lot of conflict between the Bank of Thailand and the Ministry of Finance about where the supervisory authority is going to located. As a result, there is no new Bank of Thailand Act. Pakorn Vichyanond asked whether countries other than Thailand had prevented information sharing among the commercial bank themselves, which could act as a useful channel to avoid past problems. Turner agreed that revaluation of bad loans may well be an important element of recent bank profits, but it is difficult to know how large it is. He acknowledged that the discussion of state-owned banks was one of the weakest parts of his paper in that he had not addressed the extent to which they have changed and the extent to which state-owned banks are distorting the market. Although the financial system in Asia still remains bank dominated, the rise of bank domination in South Korea is not shared by other countries. Turner argued that distance to default measures should not be published by regulators because it could give the signal that the regulator believes they are fully accurate when they are not. He suggested the shift in bank lending from firms to households was the result of a structural change as well as a lower demand from firms for funds. Before the crisis in Thailand, a program of financial liberalization was embarked upon, but the risks inherent in this process were not foreseen. Financial liberalization was carried out without an adequate supervisory framework for financial institutions, and without appropriate monetary and exchange rate policies. Sussangkarn and Vichyanond (2007) claim that crucial mistakes were the decision to liberalize capital flows while sticking to a fixed exchange rate system and trying to pursue an independent monetary policy. These mistakes substantially increased the risks to economic stability resulting eventually in the 1997 crisis. As a result of the crisis, Thailand had to abandon the fixed exchange rate system and turn to the IMF for financial assistance with its harsh conditionality. Although Thailand could exit from the IMF program by the middle of 1999, it took much longer to clean up problems in the economy, particularly corporate debt restructuring and cleaning up the non-performing loans (NPLs) of various financial institutions. Some of the key reforms resulting from the 1997 crisis that Sussangkarn and Vichyanond argue should lessen the risk of a similar crisis include: Better data for risk assessments and economic management. Before the crisis, the availability of data essential for risk assessments and economic management was woefully inadequate. The situation has improved greatly since the crisis, and should lead to more effective monitoring and early warning of potential problems. New monetary policy regime. An inflation-targeting monetary policy framework was adopted in 2000 to provide a monetary anchor. Although the process was not always smooth, the system is now well accepted by the market, but a legal underpinning for the system is needed. The targeted-inflation range also needs to be slightly narrowed. Financial sector reform. Many reforms including the introduction of a partial deposit insurance system and the development of long-term capital markets have been initiated in this area, although much of the required legal frameworks remain to be formally introduced. Sussangkarn and Vichyanond identify two sources of new risks to economic stability as political interference in financial institutions, and the lack of transparency concerning fiscal burden. One major concern is that grassroots borrowers now appear to expect that the government will always write off their debt if they cannot service it themselves. Although the Thaksin government often claimed that the fiscal position of the public sector was very healthy, the way many policies were carried out tends to hide the true future liabilities of the government. If the true lessons have been learned from the crisis, this should not have happened. Waiquamdee (2007) focuses exclusively on the lessons learned by the Bank of Thailand in the wake of the Asian crisis. The first is the introduction of inflation targeting