Adecade ago, the Asian crisis began to unfold across the region. The crisis was unprecedented in its nature and virulence. Few countries escaped unscathed. The defining characteristic of the crisis was a sudden reversal of investor sentiment and cross-border capital flows. The roots of the crisis, however, were in financial and corporate sector weaknesses not fully apparent at the time.
Other important ingredients were pegged exchange rates that encouraged excessive unhedged foreign borrowing, inadequate reserves and lack of transparency—not least about the true level of usable reserves. In most cases, traditional macroeconomic imbalances were not evident beforehand, and did not play a major role.
As private creditors stampeded for the exits, the international community—working through the International Monetary Fund (IMF)—provided substantial funding. At the same time, governments in the region adjusted policies, increasingly taking strong and appropriate actions. Also, crucial steps were taken to involve the private sector in providing financing. After some initial adjustments, confidence began to recover and capital to return. Output then recovered quite rapidly, though not before substantial economic and social damage had been done.
A central lesson from the crisis—supported by recent research—is that to reap the considerable potential gains that financial globalization offers and limit attendant risks, macroeconomic frameworks and financial sectors must be robust. This requires meeting certain standards on institutional quality, governance and transparency—preconditions not adequately met in Asia prior to the crisis.
Asia has taken this lesson to heart. Macroeconomic frameworks have been strengthened in several important respects. The most visible change is the buildup of foreign exchange reserves as a defence against future market volatility. While this is a positive development, too large a reserve buffer can be costly to maintain, can create difficulties for monetary control, and ultimately can come at the expense of an unbalanced and unsustainable pattern of growth.
Many countries have adopted more flexible exchange rate systems to better absorb external shocks, including sudden shifts in investor sentiment. Flexible exchange rates also allow greater monetary independence. However, the move toward flexibility has not been uniform.
In particular, the limited exchange rate flexibility in China makes it more difficult for other countries to allow their exchange rates to strengthen under appreciation pressures, lest competitiveness is lost in a unilateral move. This is reflected in certain cases in continued accumulation of reserves to very substantial levels.
The transparency of government policies and the overall availability of information has improved significantly. Asian governments—aided in many cases by IMF-led transparency initiatives—now routinely publish economic data, including an external debt and reserves. With many of the region’s central banks now using inflation-targeting frameworks, statements about monetary policy developments are also published regularly.
Asian countries also have launched important reforms of financial sectors and corporate governance. As a result, there has been a marked reduction in nonperforming loans, and corporate debt-equity ratios have been reduced across the board.
The lessons of the crisis have also spurred regional initiatives aimed at increasing financial integration and resilience. The crisis perhaps has created a stronger sense of regional identity. One result is that information exchange and policy dialogue have been stepped up since the crisis through various fora.
Under the Asean+3 framework, a system of bilateral swap arrangements was set up to enable individual governments to draw upon their neighbours’ resources in case of a sudden outflow of capital or other volatility. Last month, a plan was announced to turn this mechanism into a reserve pooling arrangement. IMF supports these initiatives as useful complements to its own financing.
To broaden and deepen regional capital markets, efforts are under way to promote local bond markets. Government efforts in this area—including under the Asian Bond Market Initiative and the two Asian Bond Funds—are facilitating a bottom-up process of market integration.
IMF also has changed in response to the Asian crisis.
First, we have given new emphasis to analysis and policy advice related to financial sectors, integrating them with our macroeconomic analysis. The goal is to better identify vulnerabilities and the appropriate policy responses.
Second, we do more multilateral and regional analysis to complement our country work to better define common trends, and actual and potential spillovers.
Third, we are assessing whether our financing tools for crisis prevention can be improved.
Fourth, we have a better understanding of the importance of country ownership essential to give prominence to a government’s own priorities in programme design. And we have streamlined the conditions attached to our lending to cover only issues critical to macroeconomic stability and growth.
Finally, IMF is moving ahead with governance reform to ensure that the structure of decision making better reflects global economic realities.
Asia is well placed to become an even greater force in the world economy. To fulfil this promise, new policy challenges will need to be overcome.
These include rebalancing growth toward greater reliance on domestic demand, coping with volatile capital flows and changing regional and global production patterns, and addressing problems arising from aging societies and growing inequality.
David Burton is director of the Asia-Pacific department of IMF. Comments are welcome at email@example.com