East Asia a year after

Print edition : July 18, 1998

The severity of the currency crisis affecting the Asian region and the differences between the Bretton Woods twins have encouraged policymakers and neo-liberal economists to call for a fiscal stimulus and an infusion of liquidity to halt the economic decline. But is the strategy an effective one?

A YEAR after the East Asian crisis first began with the float of the Thai baht on July 2, 1997, the international financial institutions, domestic policymakers and their advisers remain divided on the best policy to deal with the crisis. The Internationaal Monetary Fund, backed by a section of neo-liberal economists, has been arguing since the onset of the currency crisis that the countries concerned should stabilise their 'overheated' economies by reducing public expenditure and tightening their monetary policy. The pursuit of such a policy was expected to restore investor confidence, which was ostensibly undermined earlier by the high growth rates ensured through debt-financed profligacy. Leaner budgets and restricted money supply, it was argued, would, by dampening domestic demand and reducing imports, reduce the trade and current account deficits. The positive effect this would have on investor confidence, together with a rise in interest rates, was expected to render financial investment attractive, restore capital flows and stabilise currencies.

There are two problems inherent in this perspective. To start with, it prescribes a dose of deflation to countries that are in the midst of a sharp fall in economic activity. Public expenditure cuts are expected to reduce demand in countries where output is already falling because of bankruptcies and closures of overgeared corporations unable to service foreign exchange debts which have sharply increased because of currency depreciation. Second, this strategy of a double deflation does not just restrict new investments at the margin and thereby slow growth. Since it raises interest rates and the cost of domestic debt, it forces small and medium firms with only domestic debt liabilities to close down. This further worsens the downward, deflationary spiral. As a result, countries following the IMF's prescription do not experience just slow growth or even stagnation, but negative growth or contraction. This is illustrated best by the IMF's blue-eyed boy in East Asia, Thailand, in whose case growth projections for 1998 made by the international institutions themselves have slipped from a small positive figure to zero, then to a negative 4.5 per cent and now to a negative 8 per cent.

United States Treasury Secretary Robert Rubin (left) with Thai Finance Minister Tarrin Nimmanhaeminda (right) during his visit to Bangkok on June 30. Rubin affirmed that the U.S. was ready to back any additional bid for credit by Thailand from the International Monetary Fund.-THAKSINA KHAIKAEW / AP

Economies contracting at that rate can hardly hope for a restoration of investor confidence. Investors need to be convinced that an economy is on the path to recovery, before committing additional funds. Instead, they find that these economies are in a state of cumulative decline. Economic contraction reduces government revenues, increasing budget deficits associated with a given level of expenditure. If stringent fiscal deficit targets are stuck to, this reduces the size of the fiscal stimulus as recession intensifies. Thus countries pursuing this path find themselves waiting for an elusive response from foreign investors, while their economies head downwards. This tendency has got the World Bank worried as well, forcing the Bank's vice-president for East Asia and the Pacific, Jean-Michel Severino, to issue a warning that the region is on the brink of a long depression and that "the hungry can become angry". That warning, made in the course of a recent visit to the region, is being read as an official declaration on the part of the World Bank that it would prefer some moderation in the adjustment strategy being prescribed.

THE severity of the crisis affecting the region and the differences between the Bretton Woods twins have encouraged even a section of businessmen, policymakers and neo-liberal economists to call for a policy that involves a relaxation of monetary and fiscal targets. Their demand is for a fiscal stimulus in the form of higher expenditures even at the cost of a fiscal deficit and an easier monetary policy that increases access to liquidity and reduces interest rates. A combination of a fiscal stimulus, expected to be non-inflationary given the context of large unutilised capacities, and an infusion of liquidity that would bring down interest rates and shore up the balance sheets of firms, is expected at least to halt the economic decline and hopefully to trigger a recovery. Malaysia is experimenting with an easy money policy, and Singapore, which has been less affected by the crisis and normally adopts a conservative policy stance, has budgeted for a deficit of Singapore $800 million in 1998-99 as compared with a surplus of $2 billion plus last year. The fact that Malaysia and Singapore have decided to pursue such a reflationary strategy after much soul-searching, has strengthened those advancing the case for a shift from a deflationary stance to a reflationary stance.

In its rhetoric, at least, the IMF has not given in to such pressures, defending itself by focussing on the threat of inflation and currency instability associated with a policy of higher government spending. Lower rates, it argues, may increase net capital outflows and weaken currencies even further. However, the protagonists of reflation argue that depreciation may help increase exports and reduce the trade deficit and should not be a cause for worry. Despite the brave front it puts on, the pressure has begun to tell on the IMF as well, especially since expectations of a large net inflow of foreign capital remain unrealised after a year of crisis. In fact, the initial confidence of the IMF was not so much due to its belief that foreign creditors and portfolio investors would return to East Asia in the wake of IMF-style adjustment. Rather, with the crisis resulting in massive asset deflation and the currency depreciation having reduced the dollar prices of deflated assets to rock bottom levels, the Fund expected foreign firms to rush in and acquire assets at bargain prices. This is occurring to an extent, but has been slow for two reasons. First, expectations of further declines in asset prices and local currencies. Second, the recession in the region which makes asset acquisition aimed at local markets unattractive.

Meanwhile, liberalisation and deflation elsewhere in the world, including in Eastern Europe, have made available competing cheap assets including oil facilities and rare minerals. The expected rush of transnationals to East Asia may therefore remain unrealised, foreclosing the only way in which crisis-hit economies in the region can begin to show some dynamism while following the IMF's policy framework.

IN the event, the region is witnessing a virtual collapse of 'public confidence' in the international agencies for two reasons. First, the persistence and intensification of the recession in these economies despite the fact that at least two of them (Thailand and South Korea) have completely surrendered to IMF policy hegemony. Second, the perceived threat to national sovereignty resulting from a policy framework that is seen to be facilitating foreign acquisitions of corporate and other assets at deflated prices and depreciated currencies.

Faced with this situation, the IMF has been relaxing its conditions, particularly those to do with fiscal deficit, in both South Korea and Thailand. Having started with the demand that in return for an IMF-coordinated rescue package these economies should cut expenditures so as to record a relatively high budget surplus, the IMF has been changing its targets with regard to both the fiscal deficit and money supply growth in these countries.

But this change in policy on the ground in countries where it is under attack has not changed the IMF's rhetoric or the stance it is adopting in other countries in the region. In the Philippines, for example, which has been under IMF tutelage for a good part of three decades and has a new Government which has inherited an IMF stabilisation regime, the Fund is arguing that a deficit as low as 1.4 per cent of GDP is too high and is demanding a budget surplus of 50 billion pesos. Incoming Treasury Secretary Leonor Briones, who formerly headed the radical Freedom from Debt Coalition which demanded debt repudiation, was moved to comment that achieving such a surplus would be "no problem: all we have to do is close the hospitals, and let the newborn and mothers in childbirth die." Such responses notwithstanding, the IMF, with central bank support, is sticking to its guns in the Philippines.

This duplicity in practice indicates that there is no economically worked out and justified norm for the fiscal deficit in different contexts. The IMF's position could vary from the demand for a budget surplus in the Philippines to a small deficit in South Korea and Thailand to acceptance of a huge deficit in a country such as India, which is succumbing to other elements of the IMF package including financial liberalisation. The fact that there is neither any consistency nor any norm suggests that deflation per se rather than any 'technocratic' principle underlies the IMF prescription.

WHY does the IMF favour deflation wherever possible? Partly because deflation is the instrument it uses to put countries on the traverse to a regime which whittles down the role of the State and leaves "development" to the market and to private initiative. And partly because fiscal deficit targets encourage governments to sell off prime public assets cheap, and institutionally strengthen the shift to a marketist regime.

Before the crisis, these 'real' reasons why the IMF supported deflation were concealed behind two arguments. First, that greater economic space for private initiative was crucial to exploiting what was seen as a virtuous nexus between foreign investment and exports. Openness was being seen as being adequate to attract a reasonable share of the large volume of cross-border flows of investment seeking appropriate sites for production for the world market. Such capital inflows would not merely contribute to output and employment growth but would also deliver the foreign exchange needed to service the costs of foreign investment. Secondly, it was argued that a macroeconomic strategy that favoured a minimalist state was most appropriate from the point of view of winning investor confidence. Countries had to reduce the degree to which the state can, through fiscal or monetary means, interfere with signals being sent out by the market on which foreign investors rely.

The fact that pursuit of IMF-style adjustment is not attracting even portfolio investment, let alone direct investment, flows has revealed the hollowness and the ideological bias in the IMF's reasoning. In any case, the crisis itself, it is now widely accepted, originated in the hot money flows that financial liberalisation encouraged, rather than productive investment. These features have increased public scepticism about the ability of a marketist strategy to ensure a reversal of the contractionary tendency that the crisis generated.

But this is not just a case of popular disillusionment. Even international finance is losing faith in the IMF's ability to advance its interests. Despite the massive $ 100 billion-plus flow into the region being coordinated by the Fund, the Asian financial sector has stopped being the casino in which the likes of Nick Leeson and Barings could speculate. As a result, the IMF is increasingly isolated in the region. And U.S. Treasury Secretary Robert Rubin's confidence-building tour of the region to declare his Government's support for the Fund's policies has had little impact either on public, official or foreign investor sentiment.

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