TIME Asia | Let's Hear it for the IMF

NO WAY OUT: David Roche defends IMF prescriptions ANATOMY OF A CRISIS: With no end in sight to the region's financial meltdown, the devastation so far offers up some crucial lessons for the future FREE MARKETS: Chris Patten on the need for democracy	ASIA	February 2, 1998 VOL. 151 NO. 4
Let's Hear it for the IMF Critics say the fund's medicine is too drastic. But the alternative is worse By DAVID ROCHE MF-bashing is all the rage. The critics fall into several camps, but many argue that the International Monetary Fund should pursue softer options in dealing with the Asian crisis. They claim that there is no "fundamental" problem, just a financial-market panic. Consequently, they say, the IMF is imposing excessively tight monetary and fiscal policies. The critics are wrong. "Fundamental" is the most over-used word in the debate. There is nothing more fundamental than the markets, which had sound reasons to precipitate the crisis. Investors noted that Asian corporations (for this is a crisis of corporate, not government debt) were investing too much for too little gain: too many skyscrapers, "national" car factories, semiconductor plants. Much of the investment was borrowed abroad, until lenders pulled the plug, refusing to feed Asia's addiction to foreign finance. Once the money stopped flowing in, the region's currencies collapsed. The cost of debt shot up. Now borrowers can't pay, so many will go bust, causing factories to close, jobs to be lost and wealth to be destroyed. Seeing the inevitable, Asia's rich head for the door with their wealth, making it all worse. Financial crises are all about a lack of confidence; ending them is about restoring confidence. The way to do this is not to pretend that there is no "fundamental" crisis. Were this just a market panic, it wouldn't have lasted all these months. Indeed, it would not have happened at all, since Asian profitability would have been high enough to keep investors coming. But long before Asian currencies devalued, the corporate sectors of Thailand, Korea and Indonesia were unable to service their debts at any interest-rate level that reflected borrowers' risk. Foreign and domestic investors and businesses now have to be persuaded to hold Asian currencies. If they won't, today's painful adjustment will become tomorrow's deflationary spiral. And that will threaten the stability of the world's financial system by sucking countries like China (including Hong Kong), Brazil, Mexico and Russia into its black hole. Anyone who doubts this should look at how Singapore, the most prudently managed economy in the world, is being pulled down with the rest of Asia. The IMF has tried to stop the disease from spreading by imposing draconian adjustment policies on the countries in trouble. It has demanded that governments spend less and tax more, and that monetary policy be kept tight and interest rates high. Finally, it has insisted, as a condition for any bailout, on micro-reforms to make economies more efficient and to strengthen financial systems. This is tough medicine. Devaluation helps exports and cuts imports. But it also makes people poorer because they cannot afford the nice imported goodies they enjoyed before. High interest rates make everyone miserable--borrowers because they have to pay more and investors because the value of their assets falls. Reduced government spending makes the economy decline because the state accounts for a big share of total spending, about 20% in Asia. So there are many who think this medicine is too draconian. "Let Asia grow its way out of its problems with lower interest rates and higher government spending and budget deficits" is their refrain. But Asia can't. If interest rates were kept low, no one would hold the currencies. Malaysia is a nice example. Its economy is sounder than others in Asia, yet its currency has suffered as much. The government has cut spending by more than the IMF would recommend if called in. But until recently, interest rates were kept low, to avoid a debt crisis in an over-borrowed economy. The result: chronic ringgit weakness that encouraged capital flight and risked producing the same debt and deflationary spiral as elsewhere. Malaysia offers proof that low interest rates are no good option when a currency suffers from a lack of confidence. It explains why it has now decided to reverse its easy money policy to protect the currency. Then it's argued that governments should run bigger budget deficits than the IMF prescribes. After all, rich countries like the U.S. and Japan run deficits all the time. But poor ones cannot afford the luxury of misguided deficits. In poor countries, people don't save because they can't afford to. The high savings rates of Asia are the fruits of governments spending less than their income, giving them a surplus to invest in telephone systems, water supply and roads. If Asian governments start to run big deficits just as tax revenues fall with economic growth, national savings rates would tumble. That would make stabilization even more difficult. Asian countries have rudimentary markets for bonds and other fixed-income securities. So, if a government runs a deficit, it has to tap the central bank for finance. That turns the deficit into money, and the money turns into inflation. That will make the poor poorer and inspire the rich to move their money out. There are no soft options for Asia-only the hard one of cutting domestic consumption and investment so that exports rise and imports shrink. The IMF has it right. David Roche heads Independent Strategy, a London investment firm
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Critics say the fund's medicine is too drastic. But the alternative is worse

By DAVID ROCHE

MF-bashing is all the rage. The critics fall into several camps, but many argue that the International Monetary Fund should pursue softer options in dealing with the Asian crisis. They claim that there is no "fundamental" problem, just a financial-market panic. Consequently, they say, the IMF is imposing excessively tight monetary and fiscal policies. The critics are wrong.

"Fundamental" is the most over-used word in the debate. There is nothing more fundamental than the markets, which had sound reasons to precipitate the crisis. Investors noted that Asian corporations (for this is a crisis of corporate, not government debt) were investing too much for too little gain: too many skyscrapers, "national" car factories, semiconductor plants. Much of the investment was borrowed abroad, until lenders pulled the plug, refusing to feed Asia's addiction to foreign finance. Once the money stopped flowing in, the region's currencies collapsed. The cost of debt shot up. Now borrowers can't pay, so many will go bust, causing factories to close, jobs to be lost and wealth to be destroyed. Seeing the inevitable, Asia's rich head for the door with their wealth, making it all worse.

Financial crises are all about a lack of confidence; ending them is about restoring confidence. The way to do this is not to pretend that there is no "fundamental" crisis. Were this just a market panic, it wouldn't have lasted all these months. Indeed, it would not have happened at all, since Asian profitability would have been high enough to keep investors coming. But long before Asian currencies devalued, the corporate sectors of Thailand, Korea and Indonesia were unable to service their debts at any interest-rate level that reflected borrowers' risk.

Foreign and domestic investors and businesses now have to be persuaded to hold Asian currencies. If they won't, today's painful adjustment will become tomorrow's deflationary spiral. And that will threaten the stability of the world's financial system by sucking countries like China (including Hong Kong), Brazil, Mexico and Russia into its black hole. Anyone who doubts this should look at how Singapore, the most prudently managed economy in the world, is being pulled down with the rest of Asia.

The IMF has tried to stop the disease from spreading by imposing draconian adjustment policies on the countries in trouble. It has demanded that governments spend less and tax more, and that monetary policy be kept tight and interest rates high. Finally, it has insisted, as a condition for any bailout, on micro-reforms to make economies more efficient and to strengthen financial systems.

This is tough medicine. Devaluation helps exports and cuts imports. But it also makes people poorer because they cannot afford the nice imported goodies they enjoyed before. High interest rates make everyone miserable--borrowers because they have to pay more and investors because the value of their assets falls. Reduced government spending makes the economy decline because the state accounts for a big share of total spending, about 20% in Asia.

So there are many who think this medicine is too draconian. "Let Asia grow its way out of its problems with lower interest rates and higher government spending and budget deficits" is their refrain. But Asia can't. If interest rates were kept low, no one would hold the currencies. Malaysia is a nice example. Its economy is sounder than others in Asia, yet its currency has suffered as much. The government has cut spending by more than the IMF would recommend if called in. But until recently, interest rates were kept low, to avoid a debt crisis in an over-borrowed economy. The result: chronic ringgit weakness that encouraged capital flight and risked producing the same debt and deflationary spiral as elsewhere. Malaysia offers proof that low interest rates are no good option when a currency suffers from a lack of confidence. It explains why it has now decided to reverse its easy money policy to protect the currency.

Then it's argued that governments should run bigger budget deficits than the IMF prescribes. After all, rich countries like the U.S. and Japan run deficits all the time. But poor ones cannot afford the luxury of misguided deficits. In poor countries, people don't save because they can't afford to. The high savings rates of Asia are the fruits of governments spending less than their income, giving them a surplus to invest in telephone systems, water supply and roads.

If Asian governments start to run big deficits just as tax revenues fall with economic growth, national savings rates would tumble. That would make stabilization even more difficult. Asian countries have rudimentary markets for bonds and other fixed-income securities. So, if a government runs a deficit, it has to tap the central bank for finance. That turns the deficit into money, and the money turns into inflation. That will make the poor poorer and inspire the rich to move their money out. There are no soft options for Asia-only the hard one of cutting domestic consumption and investment so that exports rise and imports shrink. The IMF has it right.

David Roche heads Independent Strategy, a London investment firm