By East Asia Forum
The Asian financial crisis of 1997–98 was a huge turning point in Asia. Asia’s confidence in the IMF and the US leadership to help through global institutions in a time of crisis was seriously shaken. The disillusionment was deepest in Tokyo, Seoul, Bangkok and Jakarta — Beijing was then an innocent defender of the status quo.
The global financial crisis ten years later triggered reforms to the IMF and the global financial safety net that are still to be fully implemented. Without follow through on these reforms — to correct the disenfranchisement of the emerging Asian powers in the Bretton Woods system — the global financial system is vulnerable to Asia starting or amplifying the next financial crisis. The uncertainty and risk as China navigates its financial integration into the regional and global economy magnifies that risk.
From the middle of 1997, with Thailand, Indonesia and South Korea unable to defend their collapsing currencies from capital flight, debt denominated in US dollars ballooned, asset prices plummeted and these countries effectively became insolvent. Other countries in the region were not affected as badly, but the crisis shook Asia and brought it to its knees with a drop in incomes that more than matched that in industrial countries in the Great Depression of the 1930s.
The IMF stepped in to stop the crisis spreading but the help provided to Asia was late and the medicine was bitter, with harsh, and in retrospect unnecessary, conditionalities that had strong side-effects. The global financial crisis 10 years later saw very different policies adopted towards North Atlantic economies. Perhaps the lessons of the Asian financial crisis had been learnt; perhaps it had more to do with the weight of the North Atlantic powers in the IMF and global institutions.
The lesson for Asia was that it had to build its own defences and insurance against crises. Asian economies have accumulated vast foreign exchange reserves — increasing by almost ten-fold since before the Asian financial crisis to US$11 trillion globally today — to defend against financial shocks and capital flight. They also tried to beef up regional cooperation and laid the foundations for their own institutions in the region to protect against future financial shocks. Japan’s proposed Asian Monetary Fund was a step too far but the Chiang Mai Initiative (CMI) — a set of currency swap arrangements between countries — was created in 2000. The CMI was then multilateralised in 2010 so that any member could draw on the funds in a time of crisis.
No country has yet drawn on the CMI’s regional pool of funds. And though it doubled to US$240 billion in 2012, that’s still not enough to be of help to the region’s large economies in a time of crisis. Asia cannot rely solely on regional arrangements and nor should it. Nor can the IMF as presently constituted cover the world.
The opportunity cost of holding large foreign exchange reserves are high. US Treasury bills may be safe investments but the return is low and those funds could be mobilised in more productive investments. They also exacerbate the savings glut and currency account surpluses. Even in times of crisis countries are hesitant to use them, with none of the nine largest emerging market economies touching their reserves during the global financial crisis.
Without confidence in a global safety net there is little option but to hold trillions of dollars in reserves.
China is currently hemorrhaging foreign exchange reserves at the rate of US$100 billion a month in defending its currency. Though this is likely to stabilise, there will be ongoing uncertainty in managing risks in China’s financial market and capital account liberalisation down the track.
Asia needs a financial safety net and the current set of arrangements — the accumulation of foreign currency reserves, bilateral currency swaps and the multilateralised Chiang Mai Initiative — are not adequate. Nor does the IMF have the liquidity to bankroll a major Asian financial crisis.
The reforms prescribed and agreed to for the IMF in 2010 in the aftermath of the global financial crisis are meant to help avoid the next major crisis. They were passed by US Congress late last year and are currently being implemented. The five year gap prolonged reliance on costly alternatives. Now as the reforms are implemented, quotas and votes have been changed to better reflect the structure of the global economy, though there is more to do. The IMF does not have, nor does it have to prospect of having, adequate resources or reach unless it can serve to catalyse regional or other cooperation.
In this week’s feature essay, Adam Triggs argues that the global financial safety net ‘is too fragmented because of the significant growth in regional, bilateral and domestic arrangements that are increasingly decoupled from the IMF’.
The global financial safety net, he suggests, is also ‘too unresponsive because this fragmentation has reduced the safety net’s speed, flexibility, coverage and consistency in responding to crises’. And it is too small given the size of the global financial system.
Without an adequate financial safety net there is less confidence in financial integration into the global economy and reaping the benefits of opening up. The strength of the WTO encouraged trade integration; a robust and reliable IMF is needed for financial integration. The best option for pooling risk is at the global level, especially given how financial integration has already proceeded.
The regional arrangements play an important role but, to be effective, there needs to be coordination with the IMF. Asia, left to its own devices, would find it difficult to mobilise the resources or impose the conditions on neighbouring countries needed to manage financial crisis. It’s been difficult enough in Europe to mobilise the resources and negotiate an exit strategy, as the case of Greece demonstrates, in a region with much more political cooperation and trust.
Access to a financial lifeline before the crisis occurred or spread to other countries would have contained the Asian financial crisis. Triggs explains that making precautionary financing instruments available through the IMF would bring greater flexibility and speed in responding to crises.
For the IMF to be fully effective, emerging market economies must have a greater say. They now have increased quota and voting rights (China until very recently had the same quota and voting rights as Australia). Soon the emerging market economies will be better represented on the elected board. Quota reform had been stalled because of domestic political resistance in the United States but ultimately it was understood that it’s in the interest of the American people to better protect their own economy with a stronger global financial system.
But without a bigger and more integrated global financial safety net the risks loom large. The reform agenda is clear. The G20, the steering committee of the global economy, is chaired by China this year but the only way China can lead is collectively, through engaging the established powers, to fix the global institutions they still dominate.
The G20 was at its most effective and successful when the major powers came together in responding to the last global financial crisis. The time has come for it to act to avoid the next.
The EAF Editorial Group is comprised of Peter Drysdale, Shiro Armstrong, Ben Ascione, Ryan Manuel and Jillian Mowbray-Tsutsumi and is located in the Crawford School of Public Policy in the ANU College of Asia and the Pacific.