San Francisco Chronicle Monday, July 27, 1998
IMF Formulas Come With a High Cost :
Asia's persistent woes cast doubt on usefulness of bailoutsBy Carolyn Lochhead, Chronicle Washington Bureau
Last summer, a little-noticed financial panic rocked the small nation of Thailand. The International Monetary Fund stepped in with emergency loans to straighten out what President Clinton called "a few small glitches in the road.''
One year, $130 billion and three rescues later, the glitch has grown into the Asian financial crisis, and the big question is whether the IMF is curing or killing its patients.
The IMF has "brought the Indonesian economy to its knees,'' said Jeffrey Sachs, a prominent Harvard University economist. "It's very hard to make an economy fall by 15 percent in a year. It takes tremendous, tremendous mismanagement, in this case by the fund.''
But others, like David Hale, an economic strategist at Zurich Kemper Investments, insist just as strongly that without the IMF, "it could always have been worse.''
Worse means not only greater suffering in the crisis countries, but a global financial contagion that could engulf the developing world and throttle one of the greatest runs of prosperity Americans have ever enjoyed. Silicon Valley's high-tech sector is already suffering a sharp drop in exports to Asia, serving as an early warning of what could happen to other U.S. manufacturers if the crisis spreads.
Whether the IMF, a multilateral institution that acts as the world's lender of last resort, is doing the right thing may be the highest-stakes question since the world's last financial cataclysm, the Great Depression.
Nearly a year after the first IMF-led intervention into Thailand's "short-term liquidity crisis,'' the prognosis does not look bright:
-- Investor panic has hit Russia, which is now getting a new $22.6 billion IMF-led loan. Pakistan's economy has weakened dangerously, prompting high-level discussion of even greater IMF intervention.
-- Thailand and South Korea have sunk into severe recessions despite IMF bailouts, with no recovery in sight. More than 2 million Thais are jobless, and the economy may contract by more than 6 percent this year. Korean banks posted first-quarter losses amounting to one-third of their capital.
-- Indonesia's economy is collapsing despite IMF loans. The rupiah is plummeting, 20 million are out of work and inflation will hit 100 percent. Indonesians are suffering bigger economic losses than Americans during the Depression.
-- Japan, the world's second- largest economy, stands on the brink of a dangerous deflation. Beset by deep banking and fiscal problems, the economy is now contracting after seven years of stagnation.
-- China, ever the giant question mark, shows many symptoms of the sickness that has waylaid its neighbors, including weak banks and shaky state-directed companies.
-- The IMF itself is running out of money. If another crisis breaks out, the IMF would find itself in "grave difficulties,'' said top IMF economist Stanley Fischer.
"It's certainly hard to say by what measure (the IMF rescue plans) are working out well,'' said Brad Belt, director of international finance for the Center for Strategic and International Studies, a nonpartisan public policy research institution in Washington.
The Clinton administration is pushing hard for an additional $18 billion U.S. contribution to the fund. The increase has won overwhelming Senate approval, but House Majority Leader Dick Armey, R-Texas, promised that it will be "dead on takeoff.'' A bitter fight has delayed the House vote until September.
The holdup over the U.S. contribution hardly troubles the IMF's critics, who argue that giving more money to the fund is like dropping kerosene onto a forest fire.
They say the bailouts have rescued foreign bankers who made risky loans to Asia's once-lucrative emerging markets. That is not only unfair but dangerous, they contend, because it encourages more reckless lending.
If creditors know they will get paid even if their borrowers fail, they start making larger loans for riskier projects, encouraging dangerous business expansions and sowing the seeds of another collapse.
Carnegie Mellon University economist Allan Meltzer argues that the U.S. bailout of Mexico bondholders in 1995 presaged the Asian meltdown, and the Asian bailouts will induce an even bigger and more dangerous crisis.
"None of these so-called sophisticated, smart lenders knew the amount of total debt outstanding'' by Korean conglomerates, Meltzer said. Banks would never lend to households on such a basis, he argues, but in Korea, "they had no incentive to learn about it, because they know that if the thing goes down, the IMF will bail them out.''
In Russia, said Sachs, some investors "have been earning 100 percent per year returns investing in Russian T-bills, and we now, without asking them to take any hit at all, have rushed in with public funds to guarantee them a full repayment of all this money. It's very bad public policy.''
IMF loans are big enough to pay off some bad loans and bail out banks, but they're too small to break a panic, Sachs argues. "The billions of dollars ended up in New York and London, and nothing was accomplished,'' he said.
The fund's supporters concede that IMF loans can encourage careless lending. They agree that it would be better to have more private debt renegotiations like the agreement among foreign banks to stretch out Korea's loans.
But the IMF has no authority to force countries -- much less private creditors -- to do anything until a country asks for help, supporters say. By that time, as in Korea, the country is on the brink of default, and the chances of success are minimal.
Defaults by private companies can be healthy because they rein in reckless business expansions. But defaults by countries are different. A sovereign default cuts a country off from international credit markets, indiscriminately strangling not only sick but healthy companies. It can set an economy back for years at tremendous human cost.
"We do need to give (private) creditors a bigger hit,'' conceded Morris Goldstein, a senior analyst at the Institute for International Economics. "But the idea that we can simply do away with the IMF and we could have done away with this crisis with practically no money? That's fantasy land.''
IMF supporters say that most investors have taken punishing losses. "The fact is that losses in these markets have been really quite brutal,'' said Hale. "Anybody who was invested in Russia in the last year has lost a lot of money. The stock market went down 70 or 80 percent. . . . Do we have to go down 95 percent to make the point?''
Another wrongheaded IMF remedy, critics say, is its attempts to halt currency free-falls by jacking up interest rates. All that does is collapse the economy, hardly a way to bring back investors, they argue.
"Foreign investors have seen that crushingly high interest rates bring on bankruptcies and economic contractions and therefore don't lead to the boost in confidence that the IMF has been counting on,'' Sachs said.
A quick Indonesia default might have saved a lot of pain by freezing all debts, critics say. Indonesia will probably default anyway, Meltzer predicts. "The economy is in tatters, but the banks are going to get paid,'' he said. "That's what they call a success.''
But it is patently absurd, IMF supporters counter, to blame the IMF for Asia's financial meltdown. And that, they say, is more like like blaming the firefighter for an arsonist's work.
The Asian crisis grew from decades of economic mismanagement, magnified by sweeping changes in the world economy, where billions of dollars of investor capital can move in and out of overseas markets with the click of a mouse.
These were economies addled by lax banks, state-fattened corporations and other hallmarks of Asia's "crony capitalism.'' When market sentiment changed, collapse came quickly.
Of course, high interest rates slow growth, supporters say, but the alternative is to let currencies collapse. In countries that have huge short-term loans denominated in foreign currencies, that quickly translates into widespread bankruptcies, as even healthy companies find they can no longer pay their loans and can no longer even import the raw materials they need. As import prices soar, so does inflation.
A quick, temporary spike in interest rates is the only way to stop a disastrous currency slide. Once a currency has stabilized, interest rates can fall. But the choice -- high interest rates or a plummeting currency -- is always between the lesser of two evils.
"It is an illusion to imagine that there is some painless way of restoring confidence and stability once a country has lost its reserves and is in a crisis,'' said the IMF's Fischer in an article defending the fund's actions."It is also an illusion to imagine that by keeping interest rates low, East Asian countries could have avoided the difficult tasks and costs of financial and corporate restructuring, as the case of Japan illustrates.''
In any event, IMF supporters say, the centerpiece of the fund's remedy is not high interest rates, but sweeping structural reforms designed to cleanse a country's banking and corporate sectors.
These take time and lots of money, as Americans know from their own S&L bailouts of the 1980s. Korea and Thailand have hardly begun the process.
"These kinds of crises don't end quickly,'' said Goldstein. "In the past, it usually takes two to three years before economic growth recovers.''
IMF's Role in Restoring Struggling Economies
Q: What is the International Monetary Fund?
The IMF is an organization of 182 member nations, headquartered in Washington, D.C. It was founded in 1944 to maintain currency stability in the world economy.
A: The Fund has 2,300 staff members, mostly professional economists who monitor the members' economies and devise reform programs for those who borrow emergency loans.
Q: What does the IMF do?
A: The IMF lends money to members who experience balance of payment problems; they lack the revenue from exports to pay for their imports. Although not technically a central bank, the IMF acts as the world's lender of last resort. It can inject liquidity into a panicked market, much as the Federal Reserve can inject funds into U.S. banks to prevent bank runs or other financial instability like the U.S. stock market crash in 1987.
Q: Where does the IMF get its money?
A: The IMF operates like a credit union, lending from a pool of money contributed by members. Contributions vary by country. The U.S. contributes 18 percent of the funds and has the largest number of votes.
The money comes from a nation's central bank reserves. It earns interest and can be recalled at any time. The money is held and then lent out like a bank deposit.
IMF loans to its members are repaid with interest and have conditions attached. These conditions are market-oriented measures; sometimes they call for strict monetary and fiscal policy, or more recently in Asia, bank and other restructuring measures.
IMF members have agreed to increase the funds' lendable resources by $90 billion. This will require an additional $18 billion U.S. contribution. Because the U.S. makes the largest contribution and has the most votes, Congress can effectively veto the entire addition.
Q: How much money has been lent in the latest crisis?
A: Total loans have come to $130 billion, including emergency loans for Thailand, Indonesia, South Korea and Russia. Although the IMF has put together the loan packages, the $130 billion figure includes money from the World Bank, the IMF's sister organization that finances economic development, along with bilateral loans from Japan and other countries. Only part of the money has been disbursed so far. The IMF doles out the money gradually as the borrowing country meets loan conditions.
CHART: TAKING A TUMBLE What a difference a year makes: A look at the staggering drop in the stock market and the value of currency, relative to the dollar, of three Asian countries between June 30, 1997, and July 24, 1998. Stock Currency Market Devaluations Thailand -48% -37% Indonesia -34% -83% South Korea -54% -29%©1998 San Francisco Chronicle
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