By Philip Bowring
September 28, 1999
Hong Kong - For once, spare some sympathy for the IMF, as it struggles to keep a balance between its needs to create financial stability and to avoid moral hazard. In time for its annual meeting this week, two actions by the IMF have given a new, and reduced, view of its capabilities, so long exaggerated by its arrogance and outsiders' overestimation of its resources. Its decision to take a hands-off attitude toward Ecuador's partial default on its Brady bond interest payments has sent a shiver through Western banks and investment houses. And a report released on Saturday, ''Financial Sector Crisis and Restructuring: Lessons from Asia,'' admits some errors of policy and indicates that effective government matters more than policies or bailout money.
In Ecuador's case the IMF is acquiescing in bond market default, a decision that its critics say will undermine capital flow to all emerging markets, particularly those in Latin America whose 1980s debt problems were supposedly resolved by the Brady bonds. The Institute for International Finance, representing Western bank views, says it will also lead to a steep rise in the cost of funds. Ecuador's debt is too small to matter much in practical terms. But it does raise the question of the consequences of similar paths being taken by Russia or Brazil, for instance.
Why, though, should the private creditors not take that haircut? They were the ones who pared lending margins to developing countries to the bone. They were the ones who simultaneously encouraged lending inflow and capital flight. They were the ones who issued a stream of intellectually dishonest bond prospectuses to their clients, and contrived ways of dressing up Third World debt to get around the investment restrictions of U.S. pensions funds. They were ones who puts on ''road shows'' to promote dubious paper, and boosted the revenues of five star hotels and financial magazines, and their own bonuses, with scant regard for investor risk. They were the ones whose sudden panic in late 1997 set off a train of collapse. In South Korea this was stanched only when the government itself agreed to guarantee private sector foreign obligations. As for the impact of Ecuadoran default on the developing world, higher costs of capital for emerging markets will actually be beneficial if that deters excessive borrowing and focuses minds on achievingthe high rates of return which ought to be possible in these economies.
Indonesia meanwhile has provided the IMF with a lesson in the near impossibility of conducting effective policy when government is weak and colludes with robber-bankers in the private sector. It has acknowledged that a decision to close some banks and only compensate small depositors set off a run on much of the rest of the banking system. The liquidity that the central bank then had to provide caused a blowout in money supply and collapse of the currency. A blanket guarantee of bank deposits eventually stabilized the situation. But the awkward fact remains that the net beneficiaries of the events were big depositors who used the combination of liquidity provision by the central bank and the lack of capital controls to take much of their money out of the country while defaulting on their debts to the banks.
After the stabilization they were able to keep remaining funds in rupiah at very high interest rates. Even now these are being subsidized by the government, which must cover the ongoing losses of the now nationalized banks. According to the IMF, the cost to the public is already 51 percent of GDP and rising. The Ecuador and Asia policy slants appear to some degree contradictory. The first advises that foreign creditors must be prepared to take a hit, the second that domestic creditors are fully guaranteed, leaving the cost of default largely in the hands of government, and hence the nation as a whole rather than the big depositors who in many cases were the same people as the defaulting borrowers.
In Indonesia, however, there is still the chance that once government is changed the principles of moral hazard will be applied and the more outrageous heads-I- win-tails-you-lose crony capitalists will be dispossessed. The IMF is at least trying to lean on the Indonesian Bank Restructuring Agency to ensure that defaulters' assets are seized and dishonest bankers prosecuted. Given the chaotic situation in Jakarta that is a hard task. But there as in Ecuador, the IMF may have learned, albeit belatedly, that although stabilization is the first task of crisis management, crises will recur unless bank owners, not the local public or the international institutions, pay for their mistakes and greed. If this leads to less short-term capital movement, and more thought to risk and reward in the developing world, so much the better.
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