The IMF's Controversial Response to the Asian Financial Crisis
By Paul Brothwood
In 2004, my dissertation reached a
confident conclusion about the International Monetary Fund. The IMF had
provided emergency finance, supported reform and helped the affected economies
recover. I accepted that some of its policies caused harm, but I still wrote
that its critics were wrong. Recovery appeared to settle the argument.
The evidence inside my own dissertation was
less certain. A Thai government finance official who answered my questions said
the IMF's early measures produced a sharp economic slowdown and left no room
for an economic stimulus. The same official also credited later reforms with
improving corporate governance, transparency and accountability.
That contradiction is the right place to
start. The IMF supplied finance when private lenders were withdrawing and
national reserves were running down. Its support helped prevent a deeper
collapse. Some early conditions also intensified recession and social hardship.
Those two findings belong in the same account.
What the IMF was asked to do
The crisis countries faced an immediate
shortage of foreign currency. Banks and companies had large short-term dollar
debts, creditors refused to renew them and exchange rates were falling.
National authorities could not meet every external claim from their remaining
reserves. Emergency international support became necessary.
The IMF was the nearest institution to an
international lender of last resort, but it was not a world central bank. It
could not create unlimited liquidity. In late 1997 and early 1998, it committed
about $36 billion of its own resources to Indonesia, South Korea and Thailand,
alongside wider support from other institutions and governments.
Finance came with conditions because the
Fund needed confidence that countries would correct the weaknesses behind their
requests. Support was meant to buy time, stabilise currencies and restore
access to international lending. The dispute concerned the price of that time
and whether the prescribed changes matched the crisis unfolding across the
region.
The logic behind the programmes
The initial programmes sought to restore
confidence through tighter monetary policy, fiscal restraint, flexible exchange
rates and rapid financial reform. Higher interest rates were intended to slow
capital flight and support currencies. Budget discipline was intended to
reassure lenders. Bank closures and restructuring were meant to remove
insolvent institutions.
The Fund also pressed for better
supervision, clearer corporate information and an end to politically influenced
lending. Those reforms addressed real weaknesses described throughout my
dissertation. Banks had borrowed too much, companies carried unhedged foreign
debt and assumed guarantees had weakened commercial discipline. Reform was not
an invented problem.
The difficulty was that East Asia did not
resemble the public-debt crises for which fiscal austerity was a familiar
response. Several affected governments had entered the crisis with balanced
budgets or surpluses. The immediate failure sat largely in private debt,
banking and lost liquidity. A standard remedy risked treating the wrong part of
the economy.
Why the early medicine was controversial
High interest rates offered a clear defence
of the currency. They also raised borrowing costs for companies and banks whose
balance sheets were already damaged. A business that might have survived a
currency fall could fail once credit became unaffordable. Bank losses then
rose, lending contracted and the effort to restore confidence weakened the
institutions expected to provide it.
Fiscal restraint created a similar problem.
Cutting expenditure protected public finances, but private demand was already
collapsing. Lower government spending removed another source of economic
support. In Thailand, the official who responded to my research said tight
fiscal and monetary policy left no space to stop otherwise viable businesses
from failing.
The original logic was not absurd.
Officials feared that lower interest rates or deficit spending would cause more
capital flight. Yet policies must be judged by conditions on the ground, not
theory alone. When currencies, banks, investment and employment were falling
together, simultaneous tightening amplified the shock.
The human cost belonged in the judgment
The crisis quickly moved beyond exchange
rates and bank balance sheets. Businesses closed, unemployment rose and real
wages fell. The World Bank warned in 1998 that unemployment in Indonesia, South
Korea and Thailand was likely to more than triple from its 1996 level. It
estimated that millions of people faced a return to poverty.
Thailand showed how uneven the burden
became. Currency depreciation raised food prices for households that bought
more food than they produced. Urban job losses reduced money sent back to rural
families. Women experienced a particularly sharp rise in unemployment. Informal
family and village support was not strong enough for an economic shock of this
size.
A programme judged only by reserves,
inflation or later GDP growth misses those losses. A worker who lost a job, a
family that withdrew a child from education or a small business destroyed by
the credit squeeze did not experience recovery as a clean national statistic.
Social protection should have formed part of crisis design from the start.
The response changed as the evidence changed
The IMF did not hold every original target
in place. As the scale of the contraction became clear, fiscal positions were
eased, larger deficits were accepted and monetary policy relaxed after
currencies stabilised. Programmes also gave greater attention to social
spending and safety nets. The response became less restrictive than its first
design.
That change deserves credit. Crisis
management takes place with incomplete information, and refusing to alter a
failing assumption would have caused further harm. It also supports part of the
criticism. If later easing helped recovery, the original mix had been too tight
for the depth of the downturn. Adaptation was necessary because the early
diagnosis was incomplete. A later correction does not erase losses already
incurred, but it does show an institution willing to learn under pressure.
Country differences mattered as well. South
Korea regained stability and returned to rapid growth sooner than many
expected. Thailand's recovery took longer. Indonesia faced a deeper banking
collapse and political upheaval. The same headline treatment did not produce
the same result because each country had different institutions, debts and
political pressures.
Recovery does not settle the argument
Supporters of the IMF point to restored
currencies, stronger reserves, banking reform and renewed growth. South Korea
returned to double-digit growth in 1999. Thailand later reported stronger
governance, transparency and a less vulnerable financial system. Those outcomes
form a serious case in the Fund's favour.
The counterfactual remains unknowable.
Without IMF finance, currencies might have fallen further, defaults might have
spread and essential imports might have become harder to fund. A better
designed programme might also have secured stability with lower interest rates,
earlier fiscal support, narrower conditions and less social damage. Recovery is
consistent with each claim.
A rebound therefore does not prove that
every earlier decision was correct. Economies recover for several reasons,
including currency adjustment, export growth, private debt restructuring,
national policy, international support and the return of confidence. The final
result does not identify which intervention helped, which harmed or which
arrived too late.
What my 2004 conclusion got wrong
My dissertation acknowledged unemployment,
poverty, investor herding and criticism of austerity. It then treated later
growth as the decisive test and declared the IMF's critics wrong. That was too
certain. I had selected a theoretical argument that favoured market reform,
then allowed recovery to confirm it.
I also shifted too much responsibility to
national governments by arguing that they had chosen and implemented the
programmes. Governments did sign the agreements and remained responsible for
their citizens. Their bargaining power was limited by collapsing reserves and
closed credit markets. The Fund designed and negotiated conditions at the
moment those countries had few alternatives.
Years in banking and operations have made
me more suspicious of verdicts based only on final output. An intervention
should be tested against timing, available information, unintended consequences
and the people who carried the risk. A policy that eventually reaches its
target still deserves criticism when a less damaging route was available.
A fairer judgment of the IMF
The IMF was necessary, but necessity did
not make it infallible. Its finance and coordination reduced the risk of
disorderly default. Its pressure for stronger banks, better information and
corporate reform addressed genuine weaknesses. Its early fiscal and monetary
stance underestimated the depth of the contraction and the fragility of
businesses and households.
The better model is rapid liquidity tied to
a smaller set of urgent reforms, early involvement of private creditors,
country-specific fiscal targets and social protection built into the programme.
Conditions should address the source of the crisis instead of importing every
desirable reform into an emergency agreement. Review must begin before damage
becomes irreversible. Private creditors should also carry part of the
adjustment instead of leaving public finance to protect repayment after years
of profitable lending.
My view has therefore moved from defence to qualified support. The IMF helped stop the Asian financial crisis from becoming worse, and some of its reforms left stronger institutions behind. It also imposed early measures that deepened hardship. The honest judgment is not rescue or austerity, success or failure. It is which actions worked, when they worked and what they cost.
Asian Financial Crisis series
1. What I argued about the Asian financial crisis in 2004, and whatI think now.
2. Why the Asian financial crisis happened.
3. State versus market after the Asian financial crisis.
4. The IMF's controversial response to the Asian financial crisis.
5. South Korea, chaebols and banking failure.
6. What the Asian financial crisis can still teach us.
About the author
Paul Brothwood is an operations manager,
Chartered Environmentalist and sustainability professional based in the West
Midlands. His career has included senior leadership in banking, construction,
public service and electricity distribution. He writes about leadership,
sustainability, motorcycles, travel and lessons from earlier academic work.
This article revisits the dissertation he completed in 2004 on the Asian
financial crisis.
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