Financial Crisis: The IMF in Latin America and East AsiaTom Schaller

Introduction• There are a number of parallels that can be drawn between

the Latin American Debt Crisis (1980s) and the Asian Financial Crisis beginning in 1997.

• Though the structural causes of the two crises were different, both resulted in an increased level of involvement of the IMF in each region.

Motivation• Want to know:• Whether IMF policies made sense in either region• Whether IMF policies benefited either region• Lessons that can be taken from each crisis

• Findings:• IMF policies should have differed more between the two regions• IMF contractionary policies were harmful to both regions

Similarities• Large inflows of international short-term debt• In Asian-5: foreign bank lending increased from $210 billion at the end

of 1995 to $261 billion by the end of 1996 and $274 billion by mid-1997.

• In Latin America: net external borrowing rose from $19.4 billion in 1977 to $62.3 billion in 1981.

• Current Account Deficits• In LA: CA deficits increased 4x between 1977-81.• In Asian-5: CA deficits doubled between 1994-96.• “not sustainable”

Differences• Public vs Private Debt Holdings• LA: Gov’t debt to fund consumption• EA: Private debt to fund investment

• Large D/E ratios in East Asia• Firms more at risk to “shocks” – including policy shocks

Differences Cont.• Macroeconomic “Fundamentals”• EA: low inflation, budget surpluses or small deficits, stable or

rising foreign exchange reserves • Weak fundamentals in LA.

• Source of Crisis:• LA: Mexico announces inability to service its debt• EA: Thailand currency devaluation

Economies in Crisis• Loss of confidence in market• Massive reversal of capital• Inability to renegotiate short-term loans• Declining asset (stock, real estate, etc.) values• Rising interest rates• Exacerbated liquidity pressures

• Both regions looked to the IMF for aid

IMF Policy• In General:• Served as lender of last resort:

• Provided loans to pay off short-term debt obligations.

• In Latin America:• Currency devaluations, austerity measures, real wage

suppression, and trade liberalization.• In East Asia:• High interest rates, austerity, structural reform, and capital

controls. Also, shutting down insolvent banks.

Policy Goals• IMF hoped to restore investor confidence in both regions.• Austerity: targeted the CA deficits in both regions. Hoped to

restore ability to pay debts.• Devaluation: looked to reduce capital flight and make exports

more competitive.• Wage suppression also looked to improve exports

• High Interest Rates: hoped to attract foreign capital to stabilize currencies.

Results• In LA: Austerity not enough to generate CA surpluses, led to

import suppression.• Output loss: $361 billion between 1980 and 1983

• Even with CA surpluses and IMF liquidity, debt to GDP continued to rise.

• High interest rates increased debt burden• “Lost Decade”• Only really turned around with Brady Plan (1989).

Results Cont.• In EA: failed to improve investor confidence• “screamed fire in a theatre” – Wade (1998)

• High interest rates raised debt obligations• Hurt high D/E companies• Unnecessary bankruptcies

• Austerity and other contractionary policies made little sense based on EA’s condition

• IMF liquidity not enough to service loans• “Only when Thailand and Korea started rolling over loans did the

crisis abate” (Khakate 1998).

Conclusion• IMF is fair to “condition” their loans. They didn’t cause the

crises, but are not without blame• Contractionary policy was not the answer• Though it can be argued that it was necessary in Latin America

• Need:• Greater focus on renegotiating loans• Better monitoring to prevent crises from occurring