A Comparison of the Behaviour of the IMF in the Asian and European Financial Crises

Table of contents

1. Introduction

2. Comparison of the two financial crises
2.1 The Financial Crisis in Asia
a) Which actions did the IMF take?
b) What did the institutional environment in which the IMF acted look like?
c) How did the IMF behave and how can this behaviour be explained?
2.2 The Financial Crisis in Europe
a) Which actions did the IMF take?
b) What did the institutional environment in which the IMF acted look like?
c) How did the IMF behave and how can this behaviour be explained?

3. Conclusion

4. Bibliography

List of abbreviations

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1. Introduction

“After twenty years of service, I am ashamed to have had any association with the Fund at all.” That is one line in a letter that Peter Doyle, a top-economist at the International Monetary Fund (IMF), wrote to the IMF executive board on June 18 2012 to explain his resignation. He speaks of “incompetence” in the Funds work and of suppression of important information concerning the current financial crisis in the euro area. Where the accusations stem from and whether they express a broad based opinion within the Fund or whether they are merely the attempt to harm a former employer shall not be discussed here. What the letter leads us to is how the IMF has been subject to harsh criticism every time it appeared on stage to manage a financial crisis in any part of the world. It has been criticized for it´s internal governance, it´s group thinking and negligence of opposing views as well as for its behaviour towards the countries it has consulted and provided with financial assistance. Taking this criticism as a starting point, this paper will deal with the behaviour of the International Monetary Fund during the financial crises in Asia of the 1990s and the current financial crisis in Europe. The main interest lies in whether the political environment in Europe with the third party European Union (EU) and the institutions of the euro area causes a different incentive and power structure leading to a different behaviour on the part of the IMF in the European crisis when compared to the Asian crisis.

In Asia, the IMF was confronted with a more or less conventional regional financial crisis and it put together an individual programme for every country asking for help. In Europe on the other hand the EU represents a new, supranational, sovereign institution that has power over its member states and has become the linchpin when dealing with the European financial crisis. My thesis is that the EU-institutions (most notably the Council of the European Union, the European Commission and the European Central Bank) took over the role the IMF had in the Asian crisis and now act as the authorities that link the financial aid to conditionalities while the IMF is marginalized into the simple task of providing financial assistance. An indication for this can be seen in the way the EU (and here especially the driving force Germany) is pictured by some media as an uncompromising institution that destroys the countries which it intends to help with its tough top-down rescue plans just as the IMF was pictured during the Asian crisis.

What the paper doesn´t want to do

No assessment of the failure or success of the IMFs rescue packages for the Asian and European countries will be given. This goes beyond the initial interest and in case of the European crisis it is too early to assess as the crisis is still ongoing. Furthermore, the paper will abstract from the differences between the crises in Asia and Europe in terms of economic difficulties (exchange rate crisis, crisis of the financial sector, debt crisis). I think this is reasonable considering the focus does not lie on which kind of rescue programmes have been established, but on how the IMF behaved in the process of crisis management. Finally, the paper will not look at the bilateral loans that were granted the Asian and European countries in the respective crises. The bilateral loans are a contribution to the rescue packages tied up by the IMF and therefore mainly interfere with the size and credibility of the financial support. Their influence on the incentive and power structure is, also due to the appropriate brevity of a seminar paper, negligible.

The following main part is divided in one segment for the Asian crisis and one for the European crisis. In both I will answer the same three questions: a) which actions were taken by the IMF? b) what did the institutional environment in which the IMF acted look like? and c) how did the IMF behave and how can this behaviour be explained? By focussing on these three points I will be able to draw a line between the Asian and the European financial crisis and explain why the IMF behaves differently today in Europe than it did in the 1990s in Asia. In a concluding chapter I will summarize my results.

2. Comparison of the two financial crises

2.1 The Financial Crisis in Asia

The countries that were struck the most by the Asian financial crisis were Thailand, Indonesia and South Korea. Besides these, Malaysia, the Philippines and Singapore were also affected. Four characteristics, shared by all the countries, preconditioned the Asian crisis: a) very high rates of domestic savings, intermediated form households to firms via banks, creating a deep structure of domestic debt, b) more or less strictly fixed exchange rate regimes creating the perception of little risk in moving funds from one market to another, c) liberalization of capital markets in the early to mid-1990s and deregulation of domestic financial systems, without a compensating system of regulatory control and d) vast international inflows of financial assets creating a deep structure of foreign debt. So the consequences were simultaneous domestic and foreign debts combined with underestimated risks of capital flows due to the overrated currencies and insufficient regulation and monitoring (Wade 1998, 1540-1541). The Asian Financial Crisis started and spread in Thailand. Because of the increasing pressure on the Thai baht it had to be floated in July 1997. What followed the Thai float was a domino of the currencies in the region. All of them depreciated sharply and had to be floated. In this way the crisis spread from one country to the next and the IMF had to step in and provide financial support (cf. Ito 2007).

a) Which actions did the IMF take?

The IMF provided financial support to Thailand, Indonesia and South Korea. In total the financing added up to US$ 35 billion (about € 28 billion) (Ito 2007, 41). The IMF usually links its provision of financial aid to demands for reforms, restructuring and the like. In the language of the Fund those demands are called conditionality. In Asia the IMF applied its standard prescription to prevent a depreciation of a currency which implies monetary and fiscal tightening. Thus, taking money out of the market by raising short-term interest rates while at the same time enacting cuts to public spending. This soon proved to be a mistake in the Asian case. The economic activity in the countries quickly slowed down which in turn severed the crisis (Ito 2007, 25). As the Asian crisis did not emerge from fiscal deficits, fiscal tightening was not the right answer. The IMFs Independent Evaluation Office (IEO) admits that the initial growth assumptions for the Asian countries were unrealistic, leading to a design of macroeconomic policies that turned out to be tighter than necessary. Additionally it was said that the IMF contributed largely to the panic in the Asian financial markets by demanding those conditionality measures and immediate action on behalf of the domestic governments (IEO 2003, 36-41). As the IEO puts it: “In retrospect, the basic approach of loading the programs with an overly large agenda of structural reforms (…) seems ill-advised form a stand-point of restoring confidence” (IEO 2003, 42). This is due to the fact that commitment to a large agenda of reform is difficult to demonstrate because there will always be future political dispute on specific points. If assistance is linked to the fulfilment of the agenda as a whole this assistance becomes less credible. The resulting financial instability and unrest caused capital outflow from Asian economies instead of the inflow the IMF expected.

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