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X' dE?>c$"Small Circle"0 N~*n4Heading DA4 documents_&3k&%_%j&;&&_&3k  f   q/#/_&3k&%_%j&;&&_&3k  f j*L4QuotationQuotation in all documents/#/ 33/#/ 33 !UKUS.,TRW\6&A4 (Portrait)3'6&A43'T  _XXXX_%S%X_X  $vvzX$  C "" CP yv0vvi zvvz0   ` //v X 33_&&%_%S&&&_&   Z;      v&&&&u&&f 33    PrefaceZ;        vKu&&Kf 33    ThepresentreportwaswrittenasthemaintechnicalpaperfortheILOsHighLevel / TripartiteMeetingonSocialResponsestotheFinancialCrisisinEastandSouthEastAsianCountriestobeheldinBangkokfrom22to24April1998.  Thefirstchapterdocumentstheseverityofthecrisisintermsofitsmacroeconomicimpactandbrieflydiscussesitsnatureandorigins.Chapter2thentracesthesocialimpactofthecrisisinthethreemostseverelyaffectedcountries,namelyIndonesia,theRepublicofKoreaandThailand.  Thethirdchapterreviewsthepoliciesandprogrammesthathavebeenadoptedsofartocontainthesocialcostsofthecrisis.Aparticularconcernwastoidentifyneedsthatwerestillunmetandwaysinwhichthisgapcanbenarrowedintheshortterm.  Thefourthchapterattemptstodrawsomelessonsfromtheweaknessesinpastpoliciesandinstitutionsthathavebeenrevealedbythecrisis.Itsuggestspriorityareasforpolicyandinstitutionalreformthatneedtobeaddressedimmediatelyinordertoovercomethecurrentcrisis,toreducetheriskofsimilarcrisesinthefuture,andtoimprovethecapacitytocopewithalargeandunanticipatedriseinunemploymentandpoverty.  GiventhecentralityofinternationallabourstandardsandtripartismtotheworkoftheILOingeneralandtheimportantrolethatstandardscanplayinpromotingasociallyequitableandharmoniouswayoutofthecurrentcrisis,section4.2ofChapter4isdevotedtothistopic.  AseparatepaperonILOactionpresentsproposalsonhowtheILOcanassistitsconstituentsinthelightoftheanalysisofproblemsandpossiblesolutionscontainedinthepresentreport.  MostofthewritingforthereportwascompletedinmidMarch1998andinformationusedinitdoesnot,therefore,gobeyondwhatwasavailableatthattime.4April1998.  '     Z;      v&&&&u&&f 33    ContentsZ;  w      vKu&&Kf 33   &&\  Lx  - zvvi z-/  Lx  Preface j ..j j !!E%"iiiLxF݌  Ќ  -vvi zz-  Lx  - zvvi z-    LxB  1.  Extentandoriginsofthecrisis .0!!G%"1LxB݌   Ќ  -vvi zz-  Dr  0vvi z0/    Dr0    1.1. Originsandnatureofthecrisis.4!!G%"%"%"6DrC݌   Ќ  0vvi z0  Dr  0vvi z0/ 8   Dr\0    1.2. Outlook. !!G%"%"%"9Dr\݌  8 Ќ  0vvi z0  Lx  - zvvi z-  '  Lx  2.  Thesocialimpact . !!!F%"12LxW݌    Ќ  -vvi zz-  Dr  0vvi z0/4    DrO0    2.1. Introduction. !!F%"%"%"12DrO݌ 4  Ќ  0vvi z0  Dr  0vvi z0/R #   Dr0    2.2. Retrenchmentsandunemployment.2!!F%"%"%"13DrS݌ R  Ќ  0vvi z0  Dr  0vvi z0/p A   Drk0    2.3. Realwages. !!F%"%"%"22Drk݌ p  Ќ  0vvi z0  Dr  0vvi z0/1 _   Dr0    2.4. Changesinpovertylevels.kk-!!F%"%"%"2v 5v w 3w Drm݌ 1  Ќ  0vvi z0  Dr  0vvi z0/O }  Dr0    2.5. Increasedfragilityofsocialprotection.<!!F%"%"%"2x 7x y 5y Dr݌ O  Ќ  0vvi z0  Dr  0vvi z0/m>  DrK0    2.6. Womenworkers. !!!F%"%"%"27DrK݌ m  Ќ  0vvi z0  Dr  0vvi z0/\  Dr 0    2.7. Migrantworkerskers.  #!!F%"%"%"27Dr P!݌   Ќ  0vvi z0  Lx  - zvvi z-fz  LxY"  3.0  Policiestocontainthesocialcosts kers.RR4!!F%"%"%"31LxY""݌ f  Ќ  -vvi zz-  Dr  0vvi z0/X  Dr#0    3.1. Introductionkers. !!F%"%"%"31Dr#g$݌  Ќ  0vvi z0  Dr  0vvi z0/v  Drm%0    3.2. Economicpolicieskers.oo%!!F%"%"%"31Drm%%݌  Ќ  0vvi z0  Dr  0vvi z0/   Dr&0    3.3. Savingviableenterprises:Adjustmentattheenterpriselevelkers.Q!!F%"%"%"33Dr&v'݌   Ќ  0vvi z0  Dr  0vvi z0/>  Dr(0    3.4. Policiesandprogrammestoassistdisplacedworkerskers.G!!F%"%"%"36Dr(,)݌ > Ќ  0vvi z0  Dr  0vvi z0/\-  DrY*0    3.5. Socialprotectionkers.  %!!F%"%"%"40DrY**݌ \ Ќ  0vvi z0  Dr  0vvi z0/zK  Dr+0    3.6. Socialdialoguekers. #!!F%"%"%"45Dr+b,݌ z Ќ  0vvi z0  Dr  0vvi z0/; i  Drk-0    3.7. Policiestowardsmigrantworkerskers.}}4!!F%"%"%"49Drk--݌ ; Ќ  0vvi z0  Dr  0vvi z0/Y *   Dr/0    3.8. Concludingremarkskers.&!!F%"%"%"50Dr//݌ Y  Ќ  0vvi z0  Lx  - zvvi z-4"H!  Lx0  4.  Securingthefuture kers.b b #!!F%"51Lx0 1݌ 4" Ќ  -vvi zz-  Dr  0vvi z0/U#&#  Dr20    4.1. Economicandpoliticalreformkers.1!!F%"%"%"51Dr22݌ U# Ќ  0vvi z0  Dr  0vvi z0/s$D$  Dr30    4.2. Internationallabourstandardsandtripartismkers.WWA!!F%"%"%"52Dr34݌ s$ Ќ  0vvi z0  Dr  0vvi z0/% b%   DrA50    4.3. Employmentpolicieskers.'''!!F%"%"%"55DrA55݌ %  Ќ  0vvi z0  Dr  0vvi z0/& "&!  Dr60    4.4. Strengtheningsocialprotectionkers.3!!F%"%"%"57Dr6L7݌ & " Ќ  0vvi z0  Dr  0vvi z0/'*#'"  Dre80    4.5. Strengtheningpoliciestowardsvulnerablegroupskers.D!!F%"%"%"61Dre88݌ '*# Ќ  0vvi z0  Dr  0vvi z0/(H$($  Dr:0    4.6. Strengtheninginstitutionsforindustrialrelationskers.]]G!!F%"%"%"62Dr::݌ (H$ Ќ  0vvi z0    +'  yvv6vvi zvvi z6   ` ////v  3333&& &&&&   Z;      v&&&&u&&f 33      ff     ff   1. v ExtentandoriginsofthecrisisZ;A= =      vKu&&Kf 33    SouthEastandEastAsiahaveexperiencedaneconomicshockofunprecedentedseverity / afterdecadesofuninterruptedhighgrowth.Theenormityoftheshockiscapturedbythefactthatintheworstaffectedcountries,namelyThailand,IndonesiaandtheRepublicofKorea,realGDPgrowthhasturnedabruptlyfromover7percentperannumtozeroornegative(seetable1.1).InThailandgrowthfellfrom6percentin1996toalmostzeroin1997,withallthedeclineconcentratedinthesecondhalfofthatyear,andisprojectedtofallbyatleastafurther2percentin1998.InIndonesiathecorrespondingswingisfrom8percentgrowthuptothethirdquarterof1997toalikelyabsolutedeclineof5percentin1998.SuchshiftsinGDPoftheorderof10percentinoneyearinrelationtowhatitwouldhavebeenaccordingtolongstandingtrendsareverysevereindeed.Apartfromthesecountries,thosethathavebeenlessaffectedsofar,suchasMalaysia,SingaporeandthePhilippines,willalsoexperiencesignificantdecelerationofgrowthratesin1998.  Theseaggregateincomeshiftsreflecttheimpactsofprecipitouscurrencydevaluationsandfallsinequitypriceswhichcreatedeconomicupheavalintheirwake(seefigures1.1and1.2).Thehugedevaluationsofupto80percentintheworstcase(theIndonesianrupiahinJanuary1998)causedsevereimportcompressionintheseopeneconomiesandpushedupinflationrates.Thefallinequityandotherassetpricesfurtherdepresseddemandthroughthenegativewealtheffect.Theupshotofthesedevelopmentswasasharpfallinconsumptionandaverageincomes.  Ofgreaterconcernthanthesegeneralnegativeimpactswerethosewithdistributionalconsequences.Foremostamongthesewastheimpactonunemploymentandpoverty.Themostseverelyaffectedcountrieshaveallexperiencedmassivelayoffsandasharpriseinunemploymentasthecurrencyandfinancialcrisesimpactedontherealeconomy.Intheabsenceofunemploymentbenefitsandsocialassistancethisinflictssevereeconomichardship,wayabovethatsuggestedbythefallinGDP,onjoblosersandnewjobseekers.Togetherwithfallingrealearningsoflowpaidworkers,thiswillreversetheimpressivetrendsinpovertyreductionachievedinthesecountriespriortothecrisis.Overandabovetheseprimarycausesthereareotherfactorsmakingforariseinpoverty,suchasanincreaseinthepricesofessentialgoodsandtighterconstraintsonsocialexpenditures.  ThefirstmanifestationofthecrisiswasthesharpdevaluationoftheThaibahtinJuly1997whichthenhadsurprisinglystrongcontagioneffectsonthecurrenciesofIndonesia,MalaysiaandthePhilippinesand,toalesserextent,ofSingapore.Thesedevaluationsweremassivebyanystandardbutespeciallyinrelationtoestimatesthattheextentofovervaluationofthesecurrencies,uptotheonsetofthecrisis,wasintherangeof10to18percent.Thiscurrencycrisistriggeredverylargefallsinstockmarketsintheregion.ByOctoberthecrisishadspreadbeyondtheASEANcountriestotheRepublicofKorea.  Theprimaryfactorbehindthiscurrencyandstockmarketcollapsewasamassivereversalofforeigncapitalflows.IthasbeenestimatedthatforIndonesia,theRepublicofKorea,Thailand,MalaysiaandthePhilippinesnetprivateinflowsdroppedfromUS$93billionto12 ']"& billion"aswingof11percentofGDPbetweentheendof1996andtheendof1997.  )A%)  !v   ?&&&&?U &?&f    Figure1.1.Exchangerates,index(US$/localcurrency) Nnpre//  ?U && f /     r3t0@0,r r1  `..@@Ev3+3Et vwvwv%"v%"  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  v%"v%"vwvwt !R&&&&R &R&Source:TheEconomist,variousissues.#R&& RљT##&&&R&zT# t    Thisfinancialcollapsesoonbegantoimpactontherealeconomythroughtwomainchannels.Onewasasharplyincreasedfragilityinbankingsystemsduetoheavyexposuretounhedgedshorttermforeignloans(especiallyinThailand),andtothefurtherdecapitalizationeffectofthefallindomesticassetprices.Theotherwasadebtcrisisincorporatesectorssimilarlyexposedtoforeignloans(especiallyintheRepublicofKoreaandIndonesia).Theseeffectswereparticularlystronggiventhehighdebttoequityratioinmanylargecompaniesintheprecrisisperiodandthehighlevelofdomesticbanklendingtotheprivatesectorinthesecountries.Apartfromthisdirectimpactonforeignindebtedbanksandcompanies,secondroundeffectssoonspreadtootherpartsoftherealeconomy.Thebankingcrisis,togetherwithrisinginterestrates,resultedinacontractionofcreditandadisruptionofnormalfinancialintermediationthatputevenotherwiseviablefirmsunderpressure.Difficultiesinobtainingworkingcapitalandexportlettersofcreditaretwooftencitedexamplesoftheseperniciouseffects.Suchdisruptionsinfinancialintermediationarebelievedtohavepreventedfirmsfromreapingthefullbenefitsofthesharpcurrencydevaluations.Thisfinancialdisruptioneffectwascompoundedbytheknockoneffectsonsuppliersandotherfirmslinkedtotheinitialgroupoftroubledcompanies.  ThevirulenceofthisimpactontherealeconomyisseenintheabruptswinginGDPgrowthratesdescribedearlierandintheonsetofabsolutedeclinesinoutputinThailandandIndonesia. 0R,0 Theeffectsarebynomeansover,giventhatmanyfirmsarestillteeteringonthebrinkofilliquidityandinsolvencyandmaynotsurviveforlongwithoutthesuccessfulrestorationofconfidenceinmarkets.?&&&&?U &?&f    Figure1.2.Stockmarketindex,endperiod\npre/a  ?U && f      rN p<,(br1  `..@Ev+Ep vwvwv%"v%"  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  vwvwvwvw  v%"v%"vwvw2$}% E&&@ ESource:TheEconomist,variousissues.#E @c##&&Eb# 2$!   AstrikingfeatureofthepresentAsiancrisisistheextentofmarketoverreactionintermsofthedegreetowhichthecurrencieshavedepreciatedandassetpriceshavefallen.Theexchangeratesandmarketvaluesofmanycompaniesarestillatlevelsthatcannoteasilybejustifiedbyeconomicfundamentals.Itisalsoclearthatstabilisationistakinglongerthaninsimilarcrisesinthepastandsentimentininternationalfinancialmarketstowardsthemostaffectedcountrieshasnotyetturnedaround.Moreover,asmentionedearlier,exportshavenotyetgrowntotheextentthatwastohavebeenexpectedinrelationtothesharpdevaluations.  ItisimportanttonoteatthisstagethattherearesignificantdifferencesamongcountriesinSouthEastandEastAsiabothintermsoftheirprecrisissituationandpoliciesandintheextenttowhichtheyhavebeenhitbythecrisis.  First,intermsoftheextentofthecrisis,asalreadybrieflymentioned,thethreemostaffectedcountrieshavebeenThailand,IndonesiaandtheRepublicofKorea.Malaysiahasalso /+. experiencedacurrencydepreciationof35percentandafallinequitypricesof52percent, 0+/ similartothatofThailand,buttheimpactontherealeconomyhassofarbeenlesssevere.Growthhasslowedbutislikelytoremainpositiveintherangeof2to2.5percentin1998.Reportsonlayoffsstillshowthiseffecttobemild.AlikelyreasonforthisisthatMalaysiahadasignificantlylowerexposuretoshorttermforeigndebtwhenthecrisisbroke.Ithasthusbeenlessseverelyaffectedbytheincreaseddebtrepaymentandservicingburdencausedbycurrencydepreciation.Butitdoeshaveoneofthehighestratiosofdomesticbanklendingtotheprivatesectorandthis,inthecontextofthesharpfallinequityprices,isacontinuingsourceofvulnerability.  ThePhilippinesalsosufferedalargecurrencydepreciationandfallinsharepricesbutits   exposuretoforeignshorttermdebtisevenlowerthanthatofMalaysia.Themainimpactofthefinancialcrisisisbeingfeltthroughtheriseininterestratesthatwasintroducedtoshoreupthepeso.Thiswilldampeninvestmentandslowdowngrowthtobetween2.4and3.5percentaccordingtogovernmentforecasts,withwhichmajorinternationalfinancialhousesconcur.Moreover,giventhatitsprecrisisgrowthrateswerelowerthanthoseofotherAsiancountries(5.4percentin1996)theadjustmentburdenwillberelativelymild.  OtherAsiancountriesandareas,suchasChina,Singapore,VietNamandHongKong,   China,havefeltonlyrelativelymildeffectsfromthecrisis.HongKong,China,successfully   defendeditscurrencypegagainsttheUSdollarwhenitcameunderspeculativeattackinOctober1997butitdidsuffera20percentdropinshareprices,andpropertypriceshavealsofallen.Thehigherinterestratesandtheadversewealtheffectwilldampengrowthin1998;thisisforecastbytheGovernmenttobe3.5percent,downfromalevelof5percentinthetwoyearsimmediatelyprecedingthecrisis.ThedeclaredpolicyistomaintainthecurrencypegwiththeUSdollarsince,giventhegrowingweightofhighvalueaddedservicesandmanufacturesinitsproductionstructure,HongKong,China,isnotundulyconcernedabouttheeffectsofthedevaluationofregionalcurrenciesonitscompetitiveness.  ThestoryissimilarinSingapore.Inspiteofitsstrongfundamentals(hugeforeignexchange t andfiscalreserves,andasolidfinancialsector)SingaporewasnotentirelysparedthecontagioneffectsoftheAsiancrisis.Itscurrencydepreciatedbyamoderate15percentandthestockmarketfellby13percent.Nevertheless,growthin1997remainedatahighlevelof7.8percent.Thisisexplainedbythefactthat alargepartofSingaporesregionaltradeconsistsofintrafirmmovementsofparts,componentsandfinalproductsbymultinationalcompaniesforexporttoendmarketsintheOECDcountries.AsfinaldemandfromtheUnitedStatesandtheEuropeanUnionwashealthy,Singaporesoveralltradewasnottooseriouslyaffectedbytheregionalcrisis. J!!  1       l   However,theGovernmenthasrecentlyreviseditsgrowthforecastfor1998downwardstobetween2.5and4.5percent.Thisisbasedontheexpectationthatgrowthinthefinance,tourismandtransportationsectors,whichhaveastrongregionalorientation,willslowdownbecauseoftheregionalcrisis.However,forecastsofinternationalfinancehousesaremoreoptimisticthanthis,predictinggrowthofcloseto6percent,basedonanexpectationofstrongexportdemandfromOECDcountries.  ChinaandVietNamhavebeenrelativelyinsulatedfromthecurrencyandcapitalmarket &!' turmoilinAsiabythefactthattheyhavenotundergonesignificantliberalizationofthefinancialsectorandhavelowforeigndebtexposure.Themainimpactofthecrisiswillbefeltthroughaslowingdownofforeigndirectinvestment(FDI)inflowsfromcrisisaffectedcountriesintheregionwereimportantinvestorsinthesetwocountries.Exportgrowthisalsoexpectedtoslowdown.InthecaseofVietNam,thisisbecause70percentofitsexportsgotoSouthEastandEastAsia.Thedepressedimportdemandintheselattercountrieswillmeanslowerexportgrowthinspiteofthe15percentdevaluationoftheVietnamesedong.InthecaseofChinathemainimpactwillbefeltthroughthelossofcompetitivenessasaresultofthelargedevaluationsofregionalcurrencies,andakeyquestioniswhetherittoowillhavetodevalueinresponse.Inspite 9.)0 oftheseeffectsGDPgrowthwilldecelerateonlyslightlyinthesetwocountries.GDPgrowthin1998isforecasttobe6.5and8percent,respectively,inVietNamandChina.J    &&&&&&f 33    1.1.  OriginsandnatureofthecrisisJ{6 | r r   h'&&h'f 33    Agreatdealhasbeenwrittenontheoriginsandnatureofthecrisissinceitsonset.Apart  l fromunderstandablemediainteresttherehasalsobeenasteadystreamofanalysesoftheissuebyacademics,centralbankersandpolicymakers.b J,,  1      ׀Thereareseveralreasonsforthishighdegree   ofinterest.Oneisthesheerunexpectednessandmagnitudeofthecrisisthatstruckasetofcountrieslongconsideredas economicmiracles.AnotherisapprehensionoverthepotentialspreadofcontagioneffectsbeyondAsiatotherestoftheworldeconomy.YetanotheristhattherewerenewandunprecedentedelementsofthecrisiswhichdidnotfitstandardmodelsofcurrencyandfinancialcrisesandwhichcouldnoteasilybeunderstoodbyreferencetorecentexperiencessuchastheMexicancrisisin1995.Someofthesenewelements,suchasthesuddenandmassiveshiftinsentimentstowardsthesecountriesonthepartofinternationalfinancialmarkets,therelativeineffectivenessofeffortssofartostabilizemarkets,andthegeneralfailureonthepartofgovernments,internationalorganizationsandmarketstoanticipatethecrisis,posenewanddifficultproblemsforanalysis.Theyalsoraisecriticalissuesofnationalandinternationalpublicpolicyinthecontextofgrowingglobalizationoffinancialmarkets.Foremostamongtheseisthequestionofwhatcanbedonetoavertorreducethelikelihoodofsimilarcrisesinthefuture.  Giventhenewandasyetpoorlyunderstoodelementsinthecrisis,aswellasthefactthatwearestillinthemidstofit,itwouldbefoolishtomakefirmpronouncementsatthisstage.Moreover,itisalsoclearthatthecrisiswascausedbymanyfactorsandtheconjuncturalinterreactionamongstthem.Itisthusunlikelythatsinglingoutoneortwocauseswillyieldanadequateexplanation.Similarly,itwillbedifficulttoassignweightstoindicatetherelativeimportanceofdifferentfactors.Thebestthatcanbedoneatthisstageistohighlightsomeofthefactorsthatappear,tomanyobservers,tobeimportantpartsoftheexplanationofthecrisis.  Akeyelementisthat,regardlessofhowresponsibilityisultimatelyapportionedbetweendomesticandexternalcauses,itisclearthatthebehaviouroftheinternationalfinancialmarketwaspartoftheproblemontwocounts.Thefirstisthehighleveloflendingandinflowsofportfolioinvestmentitsanctionedintheyearsimmediatelypriortothecrisis.Withhindsightthismustcountasamarketfailuresincetheriskofsuchhighlevelsoflendingandthefactthattheyexceededthecapacityofborrowingcountriestoabsorbthefundsproductivelywerenotperceived.Thesecondistheoverreactionbeyondwhatwaswarrantedbyeconomicfundamentalsoncethecrisisbroke.OnedimensionofthiswasthelargelyindiscriminateinitialpropagationofthecurrencycrisisfromThailandtootherAsiancountrieseventhoughthereweresignificantdifferencesineconomicfundamentalsamongstthem.Theotherdimensionwasthedepthofthecurrencydepreciationandfallinequityprices,whichwentbeyondnecessarylevelsofcorrection.Itcouldbearguedthattherewasasignificantelementofselffulfillingpanicinthereactionsoftheinternationalfinancialmarket.  Buttheseimperfectionsininternationalcapitalmarketsarefarfromthewholestory.Ultimatelyitisthroughdeficienciesindomesticpolicythatthepreconditionsforthecrisiswerecreated.Whileitistruethatalltheaffectedcountrieshadpursuedsoundpoliciesincoreareassuchasthemaintenanceoffiscalbalance,lowinflation,highdomesticsavings,andopentradeandinvestmentpolicies,therewereneverthelessdeficienciesinotherareaswhichturnedouttobeserious.Thisisespeciallytrueofthehandlingoffinancialliberalizationandthefailuretoputinplaceadequateregulationofthebankingandnonbankcorporatesectorinthefaceofthenewlyacquiredeasyaccesstoforeignfunds.Itcouldofcoursebeargued,inmitigation,that ..)/ thesewererelativelynewandinherentlycomplexareasofpolicyandthattherewasnoestablishedbodyofpolicyguidelines,normuchrelevantpreviousexperience,torelyupon.Butwithhindsightitisclearthatabasicflawwastheunderestimationoftherisksassociatedwiththepoliciesandpracticesthatwerepursuedintheyearsimmediatelyprecedingthecrisis.  Fromthestandpointofoveralldevelopmentstrategyitcouldbearguedthatitwasunwisetopersistinpursuingexceptionallyhighgrowththroughincreasingrelianceonforeignborrowing.Unlikethetypicaldevelopingcountry,theseAsianeconomieshadexceptionallyhighratesofdomesticsavingofover30percentofGDP.Therewasthuslittleneedorjustificationtoseektoaugmenttheseinvestibleresourcesthroughforeignborrowing.Pushingupinvestmentratesto40percentormorethroughforeignborrowingcouldonlycontributetoaloweringoftherateofreturnfrominvestment.Asitturnedoutmuchoftheexcessinvestmentwentintofinancingassetpriceinflationandthegrowthofnontradeableactivitieswithrelativelylowreturns.Itisalsoarguablethatthereweredangersignalsofoverheatingthatwerenotactedupon.Theabruptriseinassetpriceswasacaseinpoint.Inaddition,especiallyinMalaysiaandThailand,thesharplyincreasedrelianceonforeignworkersoverthisperiodshouldhaveraisedquestionsaboutthesustainabilityoftheveryhighratesofgrowth.  Therewerealsoinadequaciesinthehandlingoftheimpactofthehugesurgeincapitalinflowsintheyearsimmediatelyprecedingthecrisis(seetable1.2).Theseinflowswereverylarge,amountingupto12.7percentofGDPinThailandin1995.Severalfeaturesofthepolicyregimessupportedtheselargeinflows.ThefirstwasthepolicyofpeggingexchangeratestothedollarinthecaseofThailandandMalaysia.Thissignalledaguaranteeagainstexchangeratelosswhichencouragedbothdomesticborrowersandforeignlenderstoincreasetheflowoffunds.Thesecondwasthecreationofincentivestoforeignborrowingbymaintainingdomesticinterestratesthatweresignificantlyhigherthantheworldmarketrate.Whileitcouldbearguedthatthiswaslargelyunavoidable,beinginparttheresultofattemptstosterilizesomeofthecapitalinflow,thisshouldhavesignalledtheneedtolookforadditionalinstrumentstodealwiththeforeigncapitalinflowproblem.?&&&&?U &?&f    Table1.2.Netcapitalflows (%ofGDP) hep/V'  ?U && f V     A E&&? 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H0.1 J 9..*)3  G JSource:IMF:WorldEconomicOutlook,InterimAssessment,Dec.1997.=31/)+* G      =A C9?&& ?&&&?&f 33   n0+* & h   Abasicshortcomingwasthefailuretoensurethatfinancialliberalizationwasaccompaniedbythedevelopmentofacommensuratecapacitytomonitorandregulatethenewlyliberatedfinancialsystem.Therewereseveraldimensionstothisproblem.Onewasaninformationgap.'h Financialliberalizationmeanttheprivatizationanddecentralizationofforeignborrowingbutnoadequatesystemswereputinplacetomonitortheextentofborrowing,anditstermstructure.Asaconsequencethegrowingproblemofoverleveraged,unhedged,shorttermborrowingwasnotperceivedearlyenough(seetable1.3).Thisinturncreatedapolicy blindspotwhichruledouttheconsiderationofpreemptivecountervailingaction.?&&&&?U &?&f    Table1.3.Internationalclaimsbyforeignbanks (US$billions)  / /   ?U && f  /      A E&&? Ef 33  *d djOyyyyyyyv%"v%",,,,I,s,,;,+  2 %  !  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Gl  Sources:BankforInternationalSettlements(BIS):InternationalBankingandFinancialMarketDevelopments c'"6 (Basle,Feb.1998);EIUCountryRiskService,fourthquarter1997andfirstquarter1998;TheEconomist,various 'O#7 issues.=31(#8 G  %   =A ?&& ?&&&?&f 33    Thiswaslinkedtotheproblemofinadequateregulationofthedomesticoperationsofthebankingsystem.Weaknessesinaccountingsystemsanddisclosurerulesmeantthattherewasalackoftransparencyabouttheoperationsandsoundnessofbanks.Thiswascompoundedbyweakprudentialregulationofthebankingsystem,especiallywithrespecttocapitaladequacyrequirements.Arelatedproblemwastheweaknessoftheprojectevaluationcapacityinbanksinthefaceofincreasedcompetitiontolendinthecontextoffinancialliberalization.This,togetherwiththeremovalofcontrolsovertheallocationofcredit,increasedtheprobabilityofaflowoffundsintothefuellingofassetbubbles.Inadditiontherewereparallelweaknessesin 60+@ thenonbankcorporatesectorwithrespecttoalackoftransparency,thepoorqualityofgovernanceandthemaintenanceofhighdebttoequityratios.Alltheseweaknessescreatedthepreconditionsforgrowingsystemicfragilityinthefinancialandnonbankcorporatesectors.  Tovaryingextentsindifferentcountries,thesebasicweaknessesweremagnifiedbythegrowthofwhathasbeentermed cronycapitalism.Connectionsbetweenpoliticiansinpowerandcertainprivateenterprisescreatedamoralhazardproblemwherebytheseenterpriseswereseenascarryinganimplicitguaranteeagainstinsolvency.Therewasthusastrongincentiveforfinancialinstitutionstolendtotheseenterprisesregardlessofthesoundnessoftheiroperations.Themoralhazardproblemaroseevenmoredirectlywhenbanksandfinancecompaniesthemselveshadclosepoliticalconnections.Insomecasestheseproblemsweremadeworsebydirectpoliticalinterferenceintheallocationofcreditandincreatingmonopoliesincertainactivities.Thesetypesofpoliticalinterferenceintheoperationofmarketsareclearlylikelytohavecontributedtotheproblemofexcessiveandmisallocatedinvestmentandaconsequentloweringoftherateofreturnoncapital.  ThissetofpolicylapsescoalescedintoacriticalmassofeconomicfragilitywhichcontributedtothemassivelossofconfidenceininternationalfinancialmarketswhentheseedsofdoubtwerefirstsowedwiththeonsetoftheThaicurrencycrisis.Italsogreatlycompromisedtheabilityoftheseeconomiestowithstandtheshockofthelargescaleoutflowofforeigncapital.Inparticular,theweaknessinthefinancialsectorprovedtohavelargenegativemacroeconomiceffects.J    &&&&&&f 33    1.2.  OutlookJ V V 1    h'&&h'f 33    Itisclearthat1998willbeabadyearbutitisfarmoredifficulttoforecasthowsoonand  howstronglytherecoverywillcome.Anoptimisticviewisthatthecrisiswillbe Vshapedinnature,thatis,adeepandsharprecessionfollowedbyanequallysteeprecovery,aswasthecaseoftherecentMexicancrisis.ButthereareseveralreasonsfordoubtingthatthiswillbethecaseinthecurrentAsiancrisis.  Abasicreasonisthatthekeytorapidrecoveryistherestorationofconfidenceinthesecountriesininternationalfinancialmarkets,buttherequirementsforachievingthisarequiteformidable.Theseextendbeyondconventionalstabilizationmeasures,suchasthereductionincurrentaccountdeficits,todifficultchallengesoffinancialsectorreformandcorporatesectorrestructuring.Apartfromtheimmediateproblemofreducingcurrentfragilityinthebankingsystem,whichwillitselfbeacostlyexerciseforgovernmentbudgets,crediblestepstocorrectthedeficienciesinfinancialsectorregulationwillalsohavetobetakensimultaneously.Thisisbecausethelossofconfidenceintheseeconomieswasprovokednotonlybytheimmediatedebtproblemsbutalsobyaperception,albeitbelated,ofsystemicfragilityinthefinancialsector.Deepreformofthefinancialsectorisinherentlydifficultandtimeconsumingandalsoinvolvesovercomingpoliticalvestedinterests.Adegreeofuncertaintythereforeremainsoverwhetherfirminitialmeasuresthatarecredibleenoughtofinancialmarketswillbeimplemented.  Similarobservationsapplytotheproblemofcorporateworkoutsandrestructuring.Thereistheimmediateanddifficultproblemofperforminga triagetosaveviableenterprisesthroughorderlyworkouts.Butthereisalsotheneedforsimultaneousactiontocorrectdeficienciesincorporategovernance,suchasthelackoftransparencyandpooraccountingsystems.Particularattentionwillneedtobepaidtotheissueofreducingthetypicallyhighdebttoequityratiosandimprudentrelianceonshorttermforeignborrowing.Asinthecaseoffinancialsectorreform,acriticalissueiswhethercrediblesignalsontheseriousnessofthereformeffortwillbesenttofinancialmarkets.  Itshouldofcoursebenotedthatthesereformeffortsarenecessarynotonlyforrestoringconfidencetointernationalfinancialmarketsbutarealsoessential,inthemselves,foreconomicrecovery.Delayedorhalfheartedreformeffortswillonlyperpetuatefragilityinthefinancialand 80+1 corporatesectorsandimpederecovery.Inparticular,withoutaswiftrestorationofconfidenceinthebankingsystemandnormalfunctionsoffinancialintermediationthepotentialrecoveryinexportspermittedbythecurrencydevaluationswillremainunderexploited.  Othersourcesofuncertaintyovertheprospectsforrecoveryremain.Oneisthequestionwhetheranexportledrecoverywillbeabletoplayitsfullrole.Onthepositiveside,therecoveryintheEuropeanUnionandcontinuedsteadygrowthintheUnitedStatesprovidefavourableprospectsforexportgrowthunlesstheytriggeroffprotectionistresponses.ButthismustbesetagainstthecontinuinguncertaintyovertheprospectsforreflationarymeasuresinJapanandthepossibilityofcompetitivedevaluationsofothercurrenciesintheregionwhichhavesofarheldfirm.Theriskofsocialunrestandpoliticalinstabilityinsomeofthemostseverelyaffectedcountriesalsohastoberecognized.  Takingalltheaboveconsiderationsintoaccount,itwouldappearthatanimmediatebouncebackishighlyunlikely.Indeedmostforecastspredictonlyamoderaterecoveryin1999.Whetherornotgrowthwill,thereafter,returntotheheadylevelsoftheprecrisisperiodmustforthemomentremainanopenquestion.  Finally,itisimportanttonotethattherearesignificantdifferencesintherecoveryprospectsforthethreemostseverelyaffectedcountries.Thisisdirectlyrelatedtotheextenttowhichtheyhaveembarkeduponandarepursuingcrediblereformmeasures.TheRepublicofKoreaandThailandappeartobeontrackforrecovery,whereasconsiderableuncertaintyremainsovertheprospectsforIndonesia.J    &&&&z&&f 33    ReferencesJhfor Di G\ G   33  xz&&xf 3333  L33E&&&&E &E&0  v Bello,W.1998. TheendoftheAsianmiracle A (Mar.1998). %"%" 0  v Camdessus,M.1998a. TheIMFanditsprogramsinAsia,NewYork,6Feb.1998(9Feb.1998) %"%" 0  v ".1998b. ReflectionsonthecrisisinAsia,Caracas,Venezuela,7Feb.1998(18Feb.1998). %"%" 0  v Condon,T.1998. SouthKorea:Thetermsoftradeshockwarrantsmonetaryeasing,MorganStanley,inGlobalEconomicForum(Mar.1998).m%"%" 0  v Feldstein,M.1998. RefocusingtheIMF:OverdoingitinEastAsia,inForeignAffairs,Mar.-Apr.1998. q%"%" 0  v Ferguson,R.W.1998. 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ThecurrencycrisisinSoutheastAsia,InstituteofSoutheastAsianStudies. %"%" 0  v Rodrik,D. Whoneedscapitalaccountconvertibility?,HarvardUniversity,Feb.1998(Mar.1998). %"%" 0  v Sachs,J.1997. ThewrongmedicineforAsia,inTheNewYorkTimes,3Nov.1997.p%"%" 0  v ".1998. Tostopthemoneypanic,inAsiaWeekOnline,13Feb.1998. t (23Feb.1998). %"%" 0  v ";Radlet,S.1998. TheonsetoftheEastAsianfinancialcrisis,Firstdraft,10Feb.1998.(Feb.1998). %"%" 0  v Stiglitz,J.1997. HowtofixtheAsianeconomies,inNewYorkTimes,31Oct.1997. %"%" 0  v ".1998a. Moreinstrumentsandbroadergoals:MovingtowardsthepostWashingtonconsensus,1998WIDERAnnualLecture(Helsinki,Finland),7Jan.1998. %"%" 0  v ".1998b. Badprivatesectordecisions,inWallStreetJournal,4Feb.1998.%"%" 0  v ".1998c. Theroleofinternationalfinancialinstitutionsinthecurrentglobaleconomy,Addresstot t u u ther r s s CouncilofForeignRelations,Chicago,27Feb.1998(10Mar.1998). %"%" 0  v Summers,L.H.1998. DeputySecretarySummersremarksbeforetheInternationalMonetaryFund,9March19981998(22Mar.1998). %"%" 0  v Wolf,M.1998. Cagingthebankers,inTheFinancialTimes,20Jan.1998.#@"%"%" #  E ej##&&  j#% [  'z"% vvTR`&6A4 LandscapeW\6&A4 (Portrait) &6A4 Landscape6&A4TP?&&&&?57&?&f    Table1.1.RealGDPgrowth(%)www.//v  ?57&&  f /     A &&?X f L  *:d&dIs;11,v,,,,,,,,,,,Y,Y,,,,Y,Y,,,,Y,_+  / " 3 G/ Y Lz  @1990@Y1990 { nAz3 @1990 @  @1991@{1991 { nAz3 @1991 @   @1992 @{1992 { nAz3  @1992  @  $@1993$@{1993 { nAz3 $@1993 $@  (@1994(@{1994 { nAz3 (@1994 (@  ,@1995,@{1995 { nAz3 ,@1995 ,@  0@19960@{1996 Y LAz 3 0@1996 0@  Y ? .z 3  ? @ 1997* : -"z   : ? .z "  ? @% 1998** : -"z   : ? .z"  ? @, 1999** V E-z G    GV ; *y  ; ; *y3  ; ; *y3  ; ; *y3  ; ; *y3  ; ; *y3  ; ; *y3  ; ; *y3  ; ; *y3  ;IMF ; *y3  ;EIU ; *y3  ;UBS ; *y3  ; ; *y3  ;IMF ; *y3  ;EIU ; *y3  ;UBS ; *y3  ; ; *y 3  ;IMF ; *y!3  ;EIU ; *y"3  ;UBS LB*y#3 G    ^GL ' x$ ' ' x%3 ' ' x&3 ' ' x'3 ' ' x(3 ' ' x)3 ' ' x*3 ' ' x+3 ' ' x,3 ' ' x-3 ' ' x.3 ' ' x/3 ' ' x03 ' ' x13 ' ' x23 ' ' x33 ' ' x43 ' ' x53 ' ' x63 ' ?5 x73 G ^ G?Thailand I?L 8 333333'@11.6333333'@I11.6 j`4L 93 333333'@11.6 333333'@ 333333 @8.1333333 @j8.1 i_3L :3 333333 @8.1 333333 @ ffffff @8.2ffffff @i8.2 i_3L ;3 ffffff @8.2 ffffff @ !@8.5!@i8.5 i_3L <3 !@8.5 !@ !@8.9!@i8.9 i_3L =3 !@8.9 !@ ffffff!@8.7ffffff!@i8.7 i_3L >3 ffffff!@8.7 ffffff!@ @6.4@i6.4 H>3L ?3 @6.4 @ H ;1L @3 # ;0.0 \R&L A3 #  ?0.4?\0.4 \R3L B3 ?0.4 ? # \0.0 ;1&L C3 #  ; 'L D3 ' 'L E3 '3.0 'L F3 '3.0 'L G3 ' 'L H3 ' H>L I3 @2.5@H2.5 i_3L J3 @2.5 @ ?1.0?i1.0 `V>L K3 ?1.0 G  ? 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H '3 ' H> 3 333333?0.3333333?H0.3 H>3!3 333333?0.3 333333? H '"3 ' '#3 ' H>$3 @2.1@H2.1 H>3%3 @2.1 @ H '&3 ' C9'3 G  ^GC M < &( G ^  GM*Estimate.**Projection. ) Sources:InternationalMonetaryFund(IMF):WorldEconomicOutlook,Mar.1998;WorldEconomicOutlook,InterimAssessment,Dec.1997;TheEconomistIntelligenceUnit(EIU): Z+ CountryRiskService,1stquarter1998and4thquarter1997;andUnionBankofSwitzerland(UBS):AsianEconomicsWeekly,27Feb.5Mar.1998.=31u, G     =A e?&& ?X&&&?&f L   J-    v  6  v  ]