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World: Financial Crises Are All Alike And All So Different

  • Robert Lyle



Washington, 17 July 1998 (RFE/RL) -- Financial crises litter the human landscape -- from the U.S. exchange rate crisis of 1894-96 to the great depression of the 1930s, from the British sterling and French franc crises of the 1960s to the global debt crisis of the 1980s. And a variety of methods have been tried to deal with them.

The Bretton Woods conference following World War II was called by world leaders who realized it was past time for some coordination of global efforts at dealing with financial and economic crisis. They set up the International Monetary Fund (IMF) and the World Bank.

Since the 1950s, the IMF has taken the lead in dealing with these crises, but fund leaders have always acknowledged that changing global economic circumstances make it extremely difficult to apply the lessons of one crisis to preventing the next.

That has been especially true in the 1990s. Three financial crises -- the Mexican of 1994-95, the Asian of 1997-98 and the Russian of 1998 -- have pointed up both the similarities and differences of the underlying problems and the proposed solutions brought to bear by the international community.

Invariably, every crisis has a mixture of elements of poor or sloppy policy-making, inattention to serious problems in banks, and carelessness in monitoring and regulating financial systems generally.

But there is one key similarity in all the 1990s crises that illuminates a central fact of the new global economy -- the speed and ease with which money can be moved from one place to another.

In Mexico, in the countries of East Asia, and in Russia, a central factor triggering each crisis was the decision by private investors and lenders to suddenly pull their money -- their investments and loans -- out of these markets. And the contagion effect this engendered sent ripples that spread the crises around the world.

In its updated World Economic Outlook report this spring, the IMF noted that the high inflation of the 1970s prompted international transactions to shift toward variable interest rates and shorter terms -- a fact that worsened the debt crisis of 1982 because so much of Latin American debt was tied to short-term rates.

The shift in the 1980s from loans to equity and bond investments was believed to make it far more difficult for sudden withdrawals of capital, but the Mexican and Asian crises clearly demonstrated the opposite -- that the dangers of high levels of foreign-currency-denominated debt which comes due in short periods of time in both the public and private sectors is the critical element.

THE MEXICAN CRISIS -- 1994-95

Mexico, a market-based economy with large elements of state ownership, especially in energy and heavy industry, was having major successes by the early 1990s after being hurt badly by the 1980s Latin American debt crisis. Mexico had dramatically reduced inflation, restarted strong economic growth and made good reductions in its fiscal deficit.

But it was a country in political turmoil and that helped delay needed reforms privatizing the large state sector, and in the structures of much of its official and private economy.

Its current account deficit was extremely high -- stretched by a steep real appreciation of the Mexican peso and a major drop in private domestic savings -- and it was being financed largely by short-term foreign money. When a sudden devaluation of the peso was taken in December 1994 in an attempt to make Mexican exports more appealing, it threatened investor interest in buying Mexican government bonds. The government then made a crucial mistake -- it replaced peso-denominated government debt with new short-term bonds called Tesobonos, which were indexed to the U.S. dollar.

It worked for a few weeks, but then unsettling international conditions prompted investors to suddenly begin pulling their money out, and Mexico was strapped to repay in the promised dollars.

The international rescue package put together by the IMF and the U.S. totaled $50.5 billion, an unprecedented amount at the time. It was contingent on a long string of conditions -- demands that Mexico immediately implement broad reforms of its economy, reduce its dependence on short-term foreign money to pay for current consumption, restart its privatization program, implement strong financial supervision, and improve transparency in all financial and economic matters.

While Mexico is still working on its reforms and privatization, it did get out of its crisis and in 1997 repaid the U.S. loan and a large chunk of the IMF loan well ahead of schedule.

IMF officials said the crisis showed that Mexico's excessive reliance on short-term external money, instead of moving to deal with its low domestic savings rate, coupled with lax oversight of domestic markets and financial institutions, and all of it masked by a lack of transparency and poor economic and financial data, made the crisis far deeper than it should have been.

THE ASIAN CRISIS -- 1997-1998

The countries of East Asia -- Indonesia, Malaysia, the Philippines, Thailand, South Korea, Hong Kong, and Singapore -- have long been called the "Asian tigers" because of their roaring economies -- growth rates averaging over 8 percent annually for the last two decades, per capita incomes rising over the last 30 years by extraordinary amounts, very high domestic savings rates, low budget deficits and low inflation.

In fact, they were held up as examples to other developing nations. Investors from around the globe rushed to invest in, and lend to, these booming, dynamic economies.

What happened? In a nutshell, they were victims of their own success. As the IMF's World Economic Outlook observed: "This success led domestic and foreign investors to underestimate the countries' economic weaknesses" and the large financial inflows overwhelmed the policies and institutions of these nations.

The fund and the association of commercial financial institutions around the world, the Institute of International Finance (IIF), agree that investors and bankers underestimated the risks as they searched for higher yields outside of Japan and Europe, where sluggish economic growth had brought low interest rates.

The problem is that a great deal of that money went, via loans and investments, into unneeded and unproductive real estate and corporate expansion. Those slowly turned into bubbles of hugely overpriced and inefficient companies and buildings.

When those bubbles began to burst, the ability of investment money to move quickly put strong pressure on currencies in the region. The crisis erupted first in Thailand after speculative attacks on the baht put the country into a tailspin, which quickly spread to other countries in the area.

Private sector expenditure and financing decisions led to the crisis, but it was exacerbated by governance issues, says the IMF, notably close and secret government involvement in the private sector and a lack of transparency in corporate and fiscal accounting.

Once again, when the crisis hit, it was made far worse as investors and lenders quickly began pulling their money out.

The IMF-led rescue package this time totaled over $113 billion, after several mis-starts and the development of serious problems in Indonesia when the fund's demand for immediate closure of 17 insolvent banks caused a run on the entire banking sector.

Indonesia's shaky political situation was part of the problem as long-time President Suharto balked at the reforms, only to be forced out of office by popular protests.

While the IMF always demands strong reforms of a country's economic structure, this time it demanded truly revolutionary changes in the basic structure of business, banking and government involvement in the economy in these countries. It wasn't the usual budget deficit the IMF was worried about, although it did urge all to cut expenses to be able to pay the costs of the crisis.

It also urged them to raise interest rates short term to try to keep some of the foreign money in place, a move that began to work only after banks were pressured by the major western industrial nations to keep their money in the region.

The Asian crisis is still not resolved, and the IMF this week, in approving Indonesia's progress so far, assembled an additional $6 billion in loans and debt rescheduling to help the country deal with the contraction that followed the first collapse.

Much of that money will be used to further strengthen Indonesia's social safety net to protect the poor.

Thailand is making better progress, and South Korea is leading the three in implementing structural reforms. But the IMF has warned that it will be years before these measures take full effect -- once they are put into place.

A major European investor in the region, Germany's Deutsche Bank, says the reforms won't be enough. In a recent analysis of the situation, the bank's experts said private debt is so huge in these countries that the interest costs are exceeding 27 percent of GDP (gross domestic product). Without broad debt rescheduling, says the bank, these Asian countries won't be able to grow out of their indebtedness.

THE RUSSIAN CRISIS -- 1998-?

Russia, struggling through the process of trying to shift from a centrally planned economy to one based on open markets, has been slipping in and out of financial and economic crises ever since the break-up of the Soviet Union. But the ripple effects of the Asian crisis -- mostly global investors reassessing just how much money they wanted to keep in what are called "emerging markets" -- put Moscow in the position of needing some strong outside support to prevent a complete collapse.

The IMF approved a three-year loan program in March 1996 for over $10 billion, but its disbursements were frequently delayed because Russia failed to meet various reform targets.

Lately, the tranches were getting back on schedule, but it was not enough. Russia's tax system, still directed to the old state-run economy, was collecting a mere fraction of expected revenues. To finance government operations, Moscow stopped paying many wages and pensions -- running up huge arrears -- and turning increasingly to government bonds and notes.

But without the broad range of reforms the IMF and others have long been pushing on Russia, both foreign and domestic investors began demanding shorter and shorter terms with higher and higher interest rates to keep buying the instruments. The situation reached its peak a week ago when rates briefly went above 120 percent.

Deutsche Bank's analysis echoes that of the IMF, saying that Russia's combination of fiscal imbalances, heavy reliance on short-term foreign borrowing, and political instability made it inevitable that a crisis would develop.

The IMF has assembled a package that would provide Russia with about $22.6 billion through the end of 1999 but has told Russian officials it will first require serious moves on a number of major reforms, most especially in the tax system.

The IMF encouraged Russia to offer investors longer-term bonds, denominated in dollars, to replace current short-term ruble notes. But interest rates on the dollar notes will be far below that on the ruble notes, so how successful that will be remains to be seen. Even then, Russia has agreed to end all short-term notes and issue all future notes with at least one-year maturities.

IMF programs all contain requirements for strengthening social safety nets to protect the poorest and most vulnerable in a society from the worst effects of the crisis. In Russia's case, that includes plans to resolve the problem of non-payments.

IMF programs are frequently adjusted to match developing conditions, and Russian officials have promised to implement by decree those reforms that aren't passed by the Duma. But to what extent the fund, the World Bank and the others who have agreed to participate in the Russian rescue package will accept that is unclear. Still unknown, as importantly, is how the investors and lenders -- both Russian and foreign -- react with their fast moving money.
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