Will Imfs Wisdom Work?

The biggest event of the year in the international financial markets was the continuing meltdown in East Asia. Who would have imagined that the problems of a few property companies in Thailand would reverberate into a currency and stock market crisis, involving all of South-east Asia, as also the tiger economies of Hong Kong and South Korea? But the unthinkable has happened and the IMF is in full play, taking the lead role in three packages totaling almost $100 billion for Thailand, Indonesia and South Korea.

Most western analysts (exc-ept Jeffrey Sachs) are exhorting the troubled countries to take the bitter medicine IMF has prescribed - tighter fiscal and monetary policies, further liberalisation, cleanup of the financial sector etc.Amazingly they continue to display such touching faith in the wisdom of the IMF, the same body which, only a few months back, had this to say in its annual report:

Directors welcomed Koreas continued impressive macroeconomic performance (and) praised the authorities for their enviable fiscal record...

Directors strongly praised Thailands remarkable economic performance and the authorities consistent record of sound macroeconomic policies.

Note the eulogies to the imp-ressive macroeconomic performance, enviable fiscal record and sound macroeconomic policies of countries that within months, are being castigated for their crony capitalism, weak financial systems and huge short-term borrowings. And, the good doctor is prescribing medicines to cut down growth.

In many ways, the seeds of the problem were sown in the sharp devaluation of the yuan in 1994. It made China supercompetitive in export markets. The impact took some time to be felt because the yen was appreciating it touched Y79 to a dollar in April 1995, thus allowing export-led growth in East Asia to continue. In 1997, as the yen exchange rate made Japanese industry competitive once again, growth in East Asia started faltering.

The high gearing of the corporates, was sustainable, if barely so, only when economic growth was rapid. The moment growth slowed, the dominoes started falling.

To add to the problem, most of these countries had huge short-term foreign currency debt obligations. And most of these were in the private sector. As confidence in the currencies, and therefore the solvency of the borrowers, was shaken, the short-term loan rollovers slowed. Hence, the need for the huge bailout packages. But whom are they bailing out? The countries and economies in difficulties, or the earlier over-enthusiastic and now suddenly reticent providers of foreign capital? Sadly, right now, the answer seems to be the latter and at the cost of the former.

This raises the question of whether the IMFs traditional austerity, deflationary measures are the right medicine. Will they cure the patient or make him sicker? Will fiscal and monetary tightness create international confidence, or will it make the worst affected corporate sector even less viable? The chances of the latter can hardly be said to be negligible. It is worth noting that the crisis in East Asia is not the result of governmental profligacy, for which the traditional macroeconomic measures were devised, but an overambitious private sector. Surely the cure should be to help sustain growth and not deflationary measures?

In this connection the experience of the Third World debt crisis of the 1980s in worth recalling. The crisis was triggered in 1982 when Mexico declared its inability to service external debts. The traditional IMF medicines were prescribed initially; they did not work. Various debt reschedulings were agreed upon; they could not be honoured. Finally, after five years of stalemate, it took an initiative by the then US Treasury Secretary, James Baker, to start the process of resolution of the debt crisis. And, this rightly emphasised the need for resumed economic growth, and sacrifices by lenders.

Baker, not an economist, had to lead traditional bankers out of the ditch they had dug themselves into, and to bring to an end the lost decade for most of South America. In its handling of the East Asian crisis, the IMF does not seem to have learnt from the events of the last decade. Fiscal compression, tighter money and bank closures are hardly calculated to boost growth. Indeed, IMF is insisting upon growth targets to be scaled down.

One other condition for most of the countries is encouragement of foreign direct investment particularly in the financial sector. In principle, this is at least logical if it leads to replacement of short-term capital going out, by long-term capital coming in. Meanwhile, investment banks are salivating at the prospects of huge fees to be earned in restructuring of corporate finances, mergers and acquisitions, debt securitisation and other avenues of financial reengineering.

Back in 1993, Irving Fisher wrote a classic article titled The Debt-Deflation Theory of Great Depression. He argued that depressions occur when entrepreneurial high spirits lead to high debt and asset values, which at some point collapse. The consequential credit contraction triggers a deflationary spiral. Is East Asia on the way? If so, the consequences for the world economy of depression in its most vibrant area can only be adverse.

But this may be too pessimistic a view. After all, many of the now troubled East Asian economies did in a decade what Britain took 50 years to achieve namely doubling the per capita incomes. They will surely come out of their present problem, even if the traditional IMF conditionality may not be much of a help.

In many ways, the seeds of the problem were sown in the sharp devaluation of the yuan in 1994. It made China supercompetitive in export market.