Why did the IMF step in to rescue Thailand?
Monday 08 September 1997
This year, the focus was on financial crises and how to handle them, with particular attention on the developing crisis in South East Asia. This column will address three linked questions that arise from this crisis. First, could it have been predicted? Second, what effect will it have on the rest of the world? And third, was the IMF right to lead a bail- out operation for Thailand?
The question of whether the crisis could have been predicted is of obvious importance to international investors, but it is also critical for policy- makers. From the point of view of the IMF, a predictable crisis is one that could potentially have been avoided by taking appropriate policy action at an early stage. So there are obvious lessons for the future, involving the possibility of more pro-active intervention by the IMF to achieve timely policy changes. And, if the crisis was predictable, there seems less case for mounting a bail-out operation in order to save the skins of private sector investors who continued to make imprudent investments despite clear warning signals.
Morris Goldstein of the Institute for International Economics in Washington presented an excellent paper at Jackson Hole which claimed, in effect, that the Thailand crisis could have been predicted, using a set of economic indicators which had been developed from a systematic analysis of previous currency crises. The key indicators, according to Dr Goldstein, are: real GDP growth, the change in exports, the rise in the real effective exchange rate, the decline in equity prices, the rise in real interest rates, and the ratio of domestic money to international reserves. Each of these indicators was flashing at least a year before the Thai crisis exploded this summer. So why did both the market, and the IMF, fail to take corrective action early enough?
One cynical interpretation, expressed at Jackson Hole, is that accurate analysis was held back from the market because the main purveyors of such information - the global investment banks - deliberately chose to place an optimistic spin on the evidence in order to win financing business from the countries concerned. From my vantage point as the chief economist of just such an organisation, this accusation does not ring true. Not only did the Asian economists of Goldman Sachs predict the onset of the crisis several months in advance, but they made this clear to clients the world over in written reports early in 1997.
Admittedly, this was a controversial conclusion at the time, but if by then it had been a consensus view, the crisis would already have happened. By the laws of chance, there will always be some commentators who can claim, in retrospect, that they were ahead of the pack. What this episode shows, though, is that Dr Goldstein is right to argue that there were plenty of publicly available warning signals well in advance of the crash. Certainly, more timely information on the true state of the central bank's reserves, and on the health of the banking sector, would have been highly valuable to investors - and the IMF is right to press for better information in future - but whether this would have prevented the crisis is a moot point.
A more likely explanation for the general failure to see the crisis coming is that markets, since time immemorial, have chosen to take advantage of the "easy" money available in fixed exchange rate systems until the very point at which they collapse. Thailand was no exception to this rule, since many investors, choosing to believe in the Thai government's obvious determination to maintain the currency peg, increased their exposure to the baht as interest rates rose in the early days of the crisis. At times such as these, markets often appear to lose their ability to accurately assess risk against return. But this particular variant of a private sector financial "bubble", painful though it may be for the participants, does not seem sufficient to justify costly intervention by the IMF.
What about the impact on the developed economies? Could this be so severe that it is in our own self-interest to bail out the worst-impacted Asian economies? With the possible exception of Japan, the answer seems to be no. The table shows the impact on the developed economies of a huge economic shock in Asia - a shock which forces the Asean countries (Thailand, Indonesia, the Philippines and Malaysia) to improve their trade deficits by 4 per cent of GDP in one year, and forces the rest of Asia to do the same by 2 per cent of GDP. This is about the most extreme shock which could be imagined, and is several times larger than anything which has happened so far. Yet even in these unlikely circumstances, the depressing impact on the US and the European Union would only be about a quarter per cent of GDP, not normally enough to raise a flicker of interest among economic forecasters. Only in Japan, where the GDP impact could be two or three times as large, and where there are also important banking sector exposures, is there a self-interested case for the bail-out.
Yet Japan in effect refused to lead the rescue operation for Thailand, and threatened not to help at all except under the auspices of the IMF. This was understandable from a Japanese political point of view, and the bluff worked. The IMF stepped in, much more speedily than it had done in several earlier crises. The question is - why?
The IMF's explanation is that there is plenty of evidence of contagion from one currency crisis to similar crises in other countries which would otherwise have not suffered any problems at all. This contagion effect justifies collective action, since all countries have an interest in protecting themselves from the danger of such fall-out. But it is rather hard to claim that the major developed economies, which have contributed the lion's share of the financial assistance to Thailand, would be the main losers from such contagion, so this explanation is not watertight.
We are left, therefore, with the final explanation, which is that the world community has a moral duty to prevent the 60 million people of Thailand from suffering as a result of the policy mistakes of their government. This, too, was suggested at Jackson Hole. Yet this justification places the IMF action squarely in the realm of a global package of humanitarian aid. And, as the ever-sparky Jeffrey Sachs of Harvard insisted, there is absolutely no case for offering such a huge package of instant support for the relatively rich Thais, when the IMF has done so little for so long to help the truly impoverished countries of sub-Saharan Africa.
IMF and central bank officials left Jackson Hole still certain that they were right to help Thailand. Exactly why was not so clear.
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