19 January 1998 00:00 [Source: ACN]Asian economies face a brutal monetary squeeze in order to meet aims laid down by the International Monetary Fund, John Richardson discovers that the squeeze may not cure Asia's ills
One Asian tiger had good reason to purr with satisfaction when the International Monetary Fund (IMF) praised its 'enviable fiscal record' in September of last year. What seems quite staggering is that only months later, IMF director Michel Camdessus lambasted this particular big cat, South Korea, for macroeconomic and financial policy blunders, sending the poor beast skulking into a corner to lick its wounds.
Did the IMF originally miss the plot, or did it get it right in September only to be now completely misreading the cause of the crisis?
The debate is likely to intensify over the coming months because of the pivotal role the IMF is playing in once proud standalone Asian economies, which just a few months ago were the envy of the west.
Jeffrey Sachs, director of the Harvard Institute for International Development, an independently funded US-based economic research organisation, firmly believes that the fund's approach is entirely wrong and poses a serious threat to the immediate and long-term prosperity of this region.
'There are no fundamental reasons for South Korea's calamity except financial panic itself,' he writes in a research paper.
'There is a need for significant financial sector reform, no cause for panic and no justification for harsh policy adjustments.' He points to a budget in surplus, low inflation, high private savings ratios and an economy poised for growth as reasons the IMF's 'draconian' conditions attached to its US$57bn rescue package make about as much sense as prising a tiger cub away from its mother.
'The IMF insists South Korea aims for an essentially unchanged inflation rate of 5.2% this year compared with 4.2% in 1997. To achieve this in the face of a huge currency depreciation will need a brutal monetary squeeze,' he says.
Petrochemical companies know what a brutal monetary squeeze feels like; in December, South Korean petrochemical imports ground to a halt because banks refused to open letters of credit (ACN 29 Dec 1997, p5).
Sachs is equally damning of the fund's insistence that the economy should be allowed to grow by only 1-2% in 1998 compared with last year's 6%.
'He is right, the IMF is in danger of turning a severe crisis into an outright recession,' says Seung Yong Shin, Seoul-based chemicals analyst with WI Carr.
'Companies need a healthy GDP (gross domestic product) growth so they can increase trade volumes to pay off their debts.' But it could be that the IMF has a motive other than promoting a return to economic stability. 'It has an agenda which goes much deeper than dealing with the crisis,' says Bill Hunsaker, ING Baring's South Korean chemicals analyst. 'The IMF wishes to dismantle the chaebols, fix the banking system and break the connections between government and business.' Laudable ambitions if you subscribe to the philosophy that the chaebols have been able to borrow extraordinarily imprudently, partly thanks to connections in high places and partly thanks to a financial system described by one western banking system as 'quite simply barking mad'.
Take the cross-debt guarantee system as an illustration. This is where a company guarantees the lending of another within the same chaebol. On the surface, a fairly sound policy if the guarantor has sufficient assets with which to underwrite its obligations. However, to use the analogy of mortgaging property, this is how cross-debting often works: Company A takes out a mortgage to buy a condominium for which it hands over a 20% deposit. It then uses the value of the whole of the property to guarantee the borrowing of not one, but often dozens of firms affiliated to the same chaebol. The end result is that this one condominium can finish up underwriting borrowings which can amount to thousands of per cent more than its value. If the bank is forced to call in its loans, it may find that company A has even failed to maintain its payments on the condominium. The 20% deposit and the resale value of the building are the only assets available to be disposed of to meet huge obligations. The cross-debt guarantees of fundamentally sound chaebol-affiliated concerns, which frequently run into hundreds of billions of won, could result in bankruptcies of the concerns, or deter foreign buyers who are increasingly viewed as the only saviours for much of South Korea's industry (ACN 8 Dec 1997, p7).
One London-based financial analyst, while accepting that the IMF is quite justified in its attempts to reform such practices, argues that reform should be a long-term objective. 'In the short term, the IMF must let GDP growth increase by more than 1-2% to enable companies to earn the revenues to pay off debts.' Similar views are being expressed at government level in Thailand, a country which was the recipient of a US$17.2bn IMF loan package in August last year. As ACN went to press, the country's Finance Minister was due to fly to Washington in an effort to persuade the institution to allow interest rates to fall and to ease the requirement for the country to this year record a 1% budget surplus. It is argued that these conditions were drawn up when the baht was the only currency which had fallen significantly in value. At that point, Thailand was in a strong competitive position in terms of exports, and thus better able to stomach high borrowing rates and a severe public spending contraction.
The Indonesian government's reluctance to instigate all the conditions attached to the country's US$43bn IMF loan may, some commentators suggest, be motivated by concerns that the conditions will prevent companies from trading their way out of crisis.
Sixty Indonesian textile companies have already been forced to close due to a lack of liquidity which is partly the result of imposition of some of the conditions to the loan. Fears are also building that a lack of short-term finance and the decline of the rupiah could undermine the viability of the country's petrochemical majors.
There is a similar credit crunch in Thailand where the IMF programme has also palpably failed to restore stability to the baht, hugely increasing the cost of imported feedstocks as product prices tumble. Some companies face acquisition or bankruptcy.
But what if the fund's primary motive is not to restore stability - either through reform of financial systems or policies which suit a country's immediate economic needs - to Asia?
'The main drive of the IMF is to ensure Asian governments have sufficient funds to help Western banks escape losses if loans made to Asian companies go bad,' argues one US economist.
He adds that two methods of attempting to ensure such funds exist are public spending cutbacks and high interest rates which should, in theory, reduce pressure on foreign reserves by attracting overseas financial market investment.
Even if he is wrong about the IMF, he is right about the exposure of western banks to the Asian crisis. A Bank of International Settlement report reveals that they continued to lend increasing amounts to South Korea, Indonesia, Malaysia and Thailand until mid-1997, despite early signs that these economies were in trouble.
The often repeated western mantra, that 'Asia is responsible for Asia's crisis because companies overborrowed and overexpanded due to overoptimistic growth estimates', sounds more than a little hypocritical. The west clearly believed the 'overoptimistic growth estimates' and has to share any blame for the crisis. But were the estimates over- optimistic?
'No, because there was no reason to assume in the early part of last year that Asia's rapid economic expansion was going to come to an abrupt halt,' says a western banking analyst.
Jeffrey Sachs contends that the halt will be turned into a contraction by the IMF's programmes. This is supported by an estimate from the research group Standard and Poor's MMS that the Thai economy will register 2% negative growth in 1998.
What should the IMF have done to prevent a contraction which looks likely to spread across Asia? 'They should have stressed to the international financial community the strengths rather than weaknesses of the South Korean economy. The markets would thereby have been convinced that there was no reason to flee the country,' he says in his article.
Months ago, when the crisis began, Sachs writes that the fund should have 'quietly encouraged Japan, the US and Europe to provide some credit support for the Bank of Korea. It should have worked with the major banks to encourage them to roll over short-term debts without inflaming panic.' When lenders were forced to roll over South Korea's debts at the end of December, it was in an atmosphere of extreme panic which saw the won fall to US$1:Won1900.
If Sachs is correct in his belief that the IMF failed to contain panic which has left currencies according to one Thai chemicals analyst 'crazily undervalued', the fund may ultimately be held responsible for a world as well as an Asian recession.
'The most crucial policy requirement for the foreseeable future is to avoid a new spiral of competitive currency depreciations. The impact of such a spiral on the US would be substantial,' writes Fred Bergsten, a senior economist, in a report submitted to a US Congress committee last November. For competitive or other reasons, Asian currencies have fallen substantially in value, even those of the widely viewed economic safe havens of Singapore and Taiwan.
Bergsten writes that the US could be flooded with cheap Asian imports as a result of the depreciations, forcing the government to pursue a more vigorous protectionist policy. He predicts that cheap imports would, if the US dollar remains at its present value, increase the US trade deficit, leading to a sharp run on the dollar due to concerns about an economic slowdown in the US.
What he describes as 'the current economic euphoria in the US' would come to a crashing halt with the subsequent decline in the dollar. Interest rates would rise and the stock market would fall, with the contagion effect sweeping across the Atlantic to Europe.
The American Bald Eagle would then, given the likely disposition of the Korean and other Asian tigers, be best advised to choose a different corner in which to retire to lick its wounds.
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