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December 3, 1998

U.S. and I.M.F. Made Asia Crisis Worse, World Bank Finds

By DAVID E. SANGER

WASHINGTON-The decision by the International Monetary Fund and the United States Treasury last year to push Asian nations to send their interest rates soaring was a crucial blunder that worsened the world financial crisis, the World Bank concluded Wednesday in a report of how the trouble started. The 200-page document deliberately omitted any direct reference to the IMF or to the Treasury, which has a major voice in the IMF's decisions. The omission, bank officials said, was a conciliatory gesture to both institutions, which have often disagreed with the bank on strategies to fix the crisis that began 18 months ago. The World Bank's blow-by-blow account of a series of cascading misjudgments places much of the blame on global investors who lent money with abandon to developing nations, and on Asian officials who were eager to accumulate the cash. But it left little doubt that in the bank's judgment the IMF and the Clinton administration shared responsibility for mishandling the initial response to the crisis.
The report also predicts that most of the afflicted nations will probably begin climbing out of recession next year, with growth continuing in 2000. But it warns that "there is still a substantial risk that the world economy will plunge into recession in 1999," particularly if Japan is unable to end its recession. The World Bank report reflects a broader debate among economists and policymakers about whether decisions by the IMF and the U.S. Treasury deepened the crisis, and whether the movement in recent years to liberalize financial markets around the world should be dramatically slowed. It argues that some system should be developed to limit the rush of short-term investments into developing countries that do not yet have the regulatory systems in place to monitor how the foreign cash is spent. "The heart of this current crisis," Joseph Stiglitz, the chief economist of the Bank, said Wednesday, "is the surge of capital flows. The surge is followed by a precipitous flow out. Few countries, no matter how strong their financial institutions, could have withstood such a turnaround, but clearly, the fact that the financial institutions were weak and their firms highly leveraged made these countries particularly vulnerable." Neither the IMF nor the Treasury, both of which saw the report before it was published, issued any public comment on it Wednesday. There are parts they agree with: IMF and Treasury officials have often blamed the huge volume of private investment into developing countries- and the refusal of investors to heed the risks associated with putting their money into countries with few regulatory safeguards-for creating the conditions that led to the bust.
But they continue to defend their initial strategy of urging Thailand, Indonesia and South Korea to raise their interest rates, a classic economic solution intended to reassure investors and stabilize national currencies. In Thailand and South Korea, those rates have now declined to about 7 percent and the currencies have stabilized, developments that IMF officials say vindicate their approach. The Bank's report argues that the strategy backfired, stabilizing the currencies at the cost of plunging the countries into deep recessions with substantial unemployment. The report asserts that the interest rate increases spread the economic pain far beyond the banks, investment funds and real estate companies that had gotten the countries into trouble to begin with, sending thousands of small businesses in to bankruptcy. "Some estimates are that levels of bankruptcy in Indonesia now are 75 percent," Stiglitz argued Wednesday, "and, you know, you cannot have a country perform with 75 percent of its firms in bankruptcy." The report was published on the day that the board of the IMF formally began its review of the latest bailout, a $41.5 billion aid package to Brazil. While the World Bank is a major participant in that bailout, it warned Wednesday against the risk of what it termed "rescue creep" as aid packages get larger and larger.
"No reasonable amount of public money can stop a justified speculative attack" on a country's currency, the report concluded. "By themselves, larger packages worsen moral hazard problems"-the risk that investors will expect governments to bail them out-"and may lead to excessively tough conditions, defeating the end objectives." The World Bank and the IMF were both created by the Bretton Woods agreement in 1944 to bring order to the world economy. The bank's primary responsibility is tending to the poor with development programs to help fend off poverty and disease; the IMF focuses chiefly on economic and monetary policy. Those differing mandates have often led them to disagreements, and two months ago Treasury Secretary Robert Rubin publicly warned both institutions that the time had come to put their differences aside. One of the many proposals floating around Washington to reform the institutions would merge their governing boards, but that would require a marriage of two very different cultures. The IMF continues to insist that it made the best judgments it could at a time of tremendous chaos last year, when the governments of Thailand and South Korea were going through elections and seemed unable to make decisions. And it argues that its program in Indonesia was undermined by the refusal of the government of President Suharto to stick to its economic agreements, and then by the political chaos that resulted in Suharto's resignation and continues on the streets to this day. Still, at a seminar early this week a senior IMF official conceded that the fund made some judgments "too quickly" and mistakenly thought it was seeing a repeat of past currency crises, particularly the one that struck Mexico in 1995. Several months ago, Stanley Fischer, the IMF's first deputy managing director, noted that "in most cases governments call us in only after they discover they are in a mess, usually because they didn't do things they needed to do long ago. If the problems were easy to solve, they'd do it themselves." Many of the conclusions in the report are likely to fuel the debate over what to do next. For example, the Bank calls for a tremendous slowdown in the movement in recent years to deregulate financial markets in developing countries, a reversal of the policy that the IMF advocated as late as April 1997, just three months before Thailand's troubles touched off the crisis.
"Financial-sector liberalization," the report adds, "which can significantly boost the risk of crisis, should proceed with care- fully and in step with the capacity to design and enforce tighter regulation and supervision." In the past year the IMF and the Treasury have begun to take the same line, stressing the need to build regulatory institutions before opening economies to huge capital flows. The Bank, however, praised the IMF's programs in several countries, including their focus on restructuring corporations and compelling countries, in return for aid, to overhaul their bankruptcy systems and inject public funds into weak banking systems. It also credited the IMF for loosening the conditions on the bailout programs to ease the pain on the poor. Still it noted that 17 million more people in Indonesia are expected to fall below the poverty line this year, as wages collapse.