The IMF and Currency Crises

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The IMF and Currency Crises
Group 10 Laurent Elfassy Ricardo Jorge Andy
Lohawatanakul Jaswinder Randhawa
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The International Monetary Fund
A UN institution

• Established in 1945
• 184 member countries
• US contribute 17.6 of total funds Japan 6.5,
  Germany 6.2, UK France 5.1

• To promote
• the balanced expansion of world trade
• stability of exchange rates
• avoidance of competitive devaluations
• orderly correction of balance of payments
  problems.

Goals

• monitors economic and financial developments and
  policies, in member countries and at the global
  level
• gives policy advice to its members
• lends to member countries with balance of
  payments problems
• provides technical assistance and training to
  governments and central banks of member countries

What does it do?
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The Asian crisis of 1997

• Massive capital outflows
• Speculative pressures on currency
• Foreign reserve depletion as central banks try to
  support currency peg (to )

Loss of confidence

• As supply of loanable funds dry up, interests
  rates soar
• Firms unable to finance their working capital
• Output drops, unemployment soar

Interest rates go up

• Crisis spreads to tightly linked regional
  economies. Thailand, Philippines, Malaysia
• Korea resists valiantly, but ultimately cannot
  handle the pressure
• Even Japan, a major exporter to these countries
  is hit

Contagion
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The Asian crisis why?

• Asian economies pegged their currency to the
  dollar, thus increasing their competitiveness
  when dollar was low.
• As dollar strengthened in 1997, economies could
  not sustain strong currencies

Strong

• Oversupply of loanable funds in preceding decades
  led to misallocation of resources
• Real Estate
• Low productivity labour
• Bad debts
• Over reliance on short term foreign funds

Weak financial sector regulations
Capital outflows

• As investors get jittery, they pull out and start
  the crisis

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IMF Reforms

• Financial Packages provided to affected economies
  to restore confidence
• IMF provided approximately 35 billion for reform
  programs
• Mobilized additional financing of 77 billion for
  reform programs from other sources

Financing

• Tightening of Monetary Policy to Stop currency
  devaluation
• Fiscal Policy was initially tightened given the
  initial view of moderate economic slowdown
  Policy adjusted later on, when it became clear
  that countries were entering severe contractions
• Currencies were allowed to float given the
  difficulties and extensive resources required for
  pegging the exchange rates

Macroeconomic Policies

• Financial Sector Reforms leading to closure of
  insolvent institutions and recapitalization of
  potentially viable institutions
• Supervision and regulation of financial
  institutions to prevent reoccurrence of the
  causes that led to the crisis.
• Efforts were made to shield poor sections of
  society by devoting substantial resources for
  subsidies on basic commodities such as rice.

Structural Reforms
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Consequences of the crisis

• Short term production affected by currency
  devaluation
• Long term growth affected by high interest rates
  and restrictions on government spending

Growth
Trade

• Reduced supply and demand throughout Asia hit
  Japan particularly hard, and US and EU further
  afield.

• Increase in unemployment
• Decrease in purchasing power, particularly for
  essential foods, medicines. Poor are hit hard
• Deterioration of social fabric (Indonesia still
  reeling)

Social
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Criticisms of the IMF?

• IMF warned SEA governments throughout 1995 and
  1996, but were ignored (IMF Annual Report 1997)
• Unreliable, untimely data supplied which skewed
  analysis

What crisis?

• High Interest Rates
• Yes, it hurts in the short run, but necessary to
  stop capital outflow and restore confidence in
  the economy
• Bank Closures
• Redistributes assets to properly regulated
  institutions
• Restores investor confidence, particularly
  through improvement of transparency
• Government Spending
• IMF misjudged severity of crisis and inhibited
  growth by placing severe restrictions. Corrected

Worse crisis

• In fact Malaysia announced a set of measures very
  similar to the ones proposed by the IMF
• IMF without the name strong technical support
  provided by IMF behind the scenes
• Is it better off? Jury still out

Malaysia