By Martin Khor
Director of Third World Network Features
October 12, 1998
As the East Asian crisis continues to deepen, the debate on the role of the International Monetary Fund's policies has heated up.
The IMF's top officials continue to defend their macroeconomic approach of squeezing the domestic economies of their client countries through high interest rates, tight monetary policies and cuts in the government budget. Their argument is that this 'pain' is needed to restore foreign investors' confidence, and so strengthen the countries' currencies.
However, some economists had already warned at the start of the IMF 'treatment' for Thailand, Indonesia and South Korea that this set of policies is misplaced as it would transform a financial problem that could be resolved through debt restructuring, into a full-blown economic crisis.
The prediction has come true, with a vengeance. The three countries under the IMF's direct tutelage have slided into deep recession. Partly due to spill over effects, other countries such as Malaysia and Hong Kong have also suffered negative growth in the year's first quarter. Even Singapore is tottering on the brink of minus growth.
For the countries afflicted with sharp currency depreciations and share market declines, the first set of problems involved: the heavy debt servicing burden of local banks and companies that had taken loans in foreign currencies; the fall in the value of shares pledged as collateral for their loans, with its resulting weakening of the financial position of banks, and inflation caused by rising import prices.
But then came a second set of problems resulting from the high interest rates and tight monetary and fiscal policies that the IMF imposed or advised. For companies already hit by the declines in the currency and share values, the interest rate hike became a third burden that broke their backs.
But even worse, there are thousands of firms (most of them small or medium-sized) that have now been affected in each country. Their owners and managers did not make the mistake of borrowing from abroad (nor did they have the clout to do so). The great majority of them are also not listed on the stock market. Therefore they cannot be blamed for having contributed to the crisis by imprudent foreign loans or fiddling with inflated share values.
Yet these companies are now hit by the sharp rise in interest rates, a liquidity squeeze as financial institutions are tight-fisted with (or even halt) new loans, and the slowdown in orders as the public sector cuts its spending.
The interest rate hike and the reluctance of many banks to provide new loans have caused serious difficulties for many firms and consumers. This has led to open complaints against the financial institutions by the business sector, and to calls by political leaders, including the Prime Minister, to find measures to reduce the lending rates.
In this matter, countries subjected to currency speculation face a serious dilemma. They have been told by the IMF that lowering the interest rate might cause the 'market' to lose confidence and savers to lose incentive, and thus the country risks capital flight and currency depreciation.
However, to maintain high interest rates or increase them further will cause companies to go bankrupt, increase the non-performing loans of banks, weaken the banking system, and dampen consumer demand.
These, together with the reduction in government spending, will plunge the economy into deeper and deeper recession. And that in turn will anyway cause erosion of confidence in the currency and thus increase the risk of capital flight and depreciation. A higher interest rate regime, in other words, may not boost the currency's level but could depress it further if it induces a deep and lengthy recession.
This is in fact what is happening. The main bright spot for Thailand, South Korea, Indonesia and Malaysia is that as recession hits their domestic economies, there has been a contraction in imports, resulting in large trade surpluses.
Unfortunately, this is being paid for through huge losses in domestic output and national income, the decimation of many of the large, medium and small firms of these countries, a dramatic increase in unemployment and poverty, and social dislocation or upheaval.
A price that is far too high to pay, and which, in the opinion of many economists (including some top establishment economists) is also unnecessary for the people of these countries to pay.
They argue that instead of being forced to raise interest rates and cut government expenditure, the countries should have been advised by the IMF to reflate their economies through increased public spending and interest rates that are lower than the present levels.
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