David C.L. Nellor
Assistant Director, Regional Office for Asia and the Pacific
delivered at the Australia Summit Conference
of the International Herald Tribune
Melbourne, Australia
June 16, 1998

In the spirit of the theme of this conference --"Regional Renewal; Opportunity In a Time of Challenge" -- I want to look beyond the immediate and pressing economic challenges facing countries in Asia and to the blueprint shaping future economic developments.

Some argue that Asia's days of high growth were numbered even before the Asian crisis erupted last year. This view, associated with Krugman, argued that Asia's high growth rates were built on ever growing commitment of resources and very little on techinical progress and productivity. Consequently, like the Soviet model, Asia's growth would come to a resounding halt when resources became scarce. To some, this expectation was realized when the Asian crisis hit and growth plummeted. Yet, just as various "limits to growth" prognostications throughout history have been swept away by innovation and technical change, new national, regional, and international institutions and policy structures can reignite sustainable growth in Asia. The challenge, in a broader context, is to secure the benefits of globalization, that Asia knows so well, while reducing the eveident risks that go along with globalization.

Let me look at developments taking place at the country, regional and international levels.

Reform at the national level

First, at the national level, countries in  Asia are building on macroeconomic stabilization by strengthening financial systems, adopting transparent corporate governance arrangements, liberalizing economic activity, and accelerating trade liberalization.  Committed and ongoing effort to these structural changes will deliver markets that allocate realistically valued assets to productive use. The already high savings rate, recognition of the key role of education, and legendary entrepeneurial effort of Asian economies provides the means to support this more productive investment.

Some observers have criticized these reforms, arguing that, even if these measures may be appropriate on their own merits, they have no place in an IMF-supported reform program. But, there is no reason for the international community to provide financial assistance to a country unless that country takes measures to prevent future crises. Beyond this, whatever one believes to be the cause of the present crisis, the experience of the past few months provides a clear lesson. Structural measures, such as improvements in corporate governance, are essential ingredients for restructuring and recapitalization. Strong and comprehensive reform is required to restore confidence in the currency and credibility to policies. The failure to adopt strong and comprehensive reforms simply raises the credibility threshold making the inevitable second round of policy reform even more difficult.

A second question is where are we in the reform process?

External current account balances have adjusted rapidly; Korea and Thailand are recording surpluses and current account deficits are narrowing rapidly throughout the region. At this stage, however, this has reflected largely compression of imports as domestic demand has fallen. Export volumes have been boosted by destocking in Asia combined with strong US demand. However, extremely weak export prices have offset this strong export volume performance.

Private capital flows to Asia have resumed; a remarkable turnaround in just a few months since the peak of the crisis. Korea has successfully rolled over bank debt and its $4 billion soveriegn debt issue was heavily oversubscribed. Phillipines issued sovereign debt of $0.5 billion. Private companies have issued bonds and sizable equity placements have been made. Both Thailand and Phillipines succecssfully made large public-sector loans. Venture capital investors have been active in the region and, although the amounts are difficult to quantify, anecdotal reports suggest available funds are high. Direct investments have also resumed.

Despite these favorable developments, the scale of recapitalization in the crisis countries is dauntingly large. In Thailand, for example, successful equity placements undertaken by Bangkok Bank and Thai Farmers Bank are just the beginning of the exercise. The authorities have effectively recapitalized many instiutions and, over time, these institutions will need to be privatized. In this regard, Korea is preparing a privatization plan for Korea First and Seoul Bank and is to receive bids for these banks by mid-November. Of course, recapitalization extends beyond the banking sector to overly geared corporations and to governments that are seeking to restore their international reserves by raising funds in private capital markets.

The restucturing of financial sectors is well advanced and moving in line with expectations in Thailand and Korea. Other countries in the region are also strengthening banking systems. As part of this process, countries are building financial sector infrastructure by improving supervision and prudential standards. In Thailand, for example, rules for loan classification and provisioning that meet international best practices will be phased in over two years commencing July 1. In Korea, a legal framework has been enacted to help strengthen the regulatory  and supervisory system. The new supervisory agency will publish its proposals for prudential regulations by end June and they will be issued in their final form by August 15.

A legal framework to strengthen governance is being established. In Korea, for example, restrictions on mergers and acquisitions have been eased, accounting standards of listed companies are being brought into line with generally accepted practices, and consolidated statements are required. Bankruptcy provisions are being strengthened and allowed to operate without the interference of government. In Thailand, the authorities are strengthening the supervisory and prudential arrangements for the financial sector, pursuing privatization in major sectors, amending bankruptcy and foreclosure rules to help put distressed assets back to work.

Realism calls for patience and international cooperation with many of these structural reforms. The legal and regulatory framework is critical to provide the foundation for improving governance and supervision, but to develop the capacity to implement such measures will take time and the support of the IMF, Asian Development Bank, World Bank, and countries including Australia.  We know,  for example, that it will take some years to build the supervisory capacity of the regulatory institutions to adequate levels.

What does all this add up to?

Reform has delivered impressive changes over the last several months in Thailand and Korea, but the policy challenges that remain are also considerable. In Indonesia the challenges that remain are also considerable. In Indonesia the challenges are, of course, enormous. Let me offer an analogy to characterize the reform process; place the country in the shoes of a marathon runner. A first feature is the strong mental preparation to build the determination to face the physical challenge posed by a marathoner -- without that you will not get to the starting blocks.  Unfortunately, in the crisis countries, arriving at this dedicated commitment and political will to carry out reform took much of the last half of 1997.  Moreover, even before they begin the marathon, runners know that they will confront pain at certain stages of the race.  If they are to be successful, however, they have to fight their way through that so-called "wall of pain" I would argue that we are presently encountering the first "wall of pain" in the reform process. Growth is slowing and the unfortunate social costs of adjustment are appearing. This is perhaps just the first such challenge.  We also know that, besides mental attitude, fitness, and determination, various factors outside the runner's control often influence success. In this regard, developments, such as the weakness in the Japanese economy, have not helped the reforming countries and perhaps slowed the pace at which reform might bear fruit.  In other words, these domestic and external considerations will help determine whether this is a two hour or three hour marathon. Neverthesless, those countries that sustain reform through these difficult periods will see the fruit of their efforts. For these countries, growth can recommence as the policy reform proceeds.

Developments at the regional level

Let me turn now to developments at the regional level. At the regional level, Asian countries are rethinking their mutual responsibilities. The idea of regional macroeconomic surveillance was agreed last November in the Manila Framework for Enhanced Regional Cooperation.  This Manila Group has a critical mix of fourteen emerging and key industrial economies along with the World Bank, Asian Development Bank and the IMF as secretariat. In a process some have charaterized as peer pressure, review of economic policy issues, greater transparency of data provision, and technical cooperation to strengthen financial sectors and deepen fixed income markets are high on the agenda. Agreeing, in the context of international efforts, on common guidlines or standards in areas such as financial supervision, prudential requirements, or data provision is a possible further step. Region-wide adoption of principles in these areas can help make reform more effective and help countries adopt measures that, if introduced by any individual country, might be seen as harming its competitive position.

In looking at the regional level, one cannot go past the enormously important role to be played by Japan and the critical importance, at the present juncture, of the yen in anchoring financial stability. Let me spend a few moments on this issue recognizing that Japan is the key regional actor that can play a constructive role in building an Asian recovery. The "numbers" on Japan's role in Asia are widely known as a key trading partner, as a major source of foreign direct investment, and as an important bank lender.  Just as important, however, are the indirect consequences of yen weakness. On the trade front, the increased US current account deficit - already some $100 billion - matching Asia's external adjustment will be increased further by a weak yen thereby raising several risk factors for the global outlook.  One direct investment, some are concerned about the domestic Asian political implications of large scale US direct investment, these concerns will only be increased by a weak yen.

What to do? Support of the yen rests on the Japanese government adopting strong and bold measures to strengthen its domestic economy. I will make two points. First, the Japanese government has made a fundamental and profound policy shift in recent months. The government has recognized a role for public funds in financial sector restructuring and placed a major fiscal stimulus package on the agenda. These steps have perhaps been insufficiently recognized - together these measures amount to an equivalent of about 75 percent of Australia's GDP. The fiscal package adopted includes 2.5 percent of GDP in so-called "real water" measures. The injection of public funds, equal to about 6 percent of GDP, goes into deposit insurance and restructuring the financial sector.  Mr second point is that what is needed know is for these encouraging steps to be built upon; the injection of public funds into the financial sector must be a catalyst to serious reform and the fiscal stimulus must not be withdrawn but turned into the first move in a medium term fiscal reform.

Architecture of the international financial system

My third section deals with the architecture of the international financial system. At the international level, the task is clear but challenging - to strengthen the international financial system to reduce the likelihood of crises; and when crises occur, as they almost certainly will, to reduce their harmful consequences. What is on the agenda here?

Making surveillance more effective and improving data collection and dissemination

Ways need to found to enhance the effectiveness of Fund surveillance by ensuring, among other things, that all relevant data are made available, and, that the IMF's policy advise and warnings are acted upon. On the agenda is whether the Fund should provide more public information and if necessary issue public warnings. One proposal is to develop a "tiered response" under which countries believed to be seriously off course are given increasingly strong warnings.

The Fund has been told to intensify its work in surveillance of financial sector issues and capital flows. Work is taking place toward an amendment of its articles of agreement that will make the liberalization of capital movements a purpose of the Fund. This amendment will enable the Fund to encourage orderly liberalization of the capital account recognizing the importance of appropriate macroeconomic and exchange rate policies and a strong and well supervised financial system.

The availability of timely, accurate, and comprehensive data to the public is an essential pillar of the strengthened financial system.  Through the Special Data Dissemination Standard, the IMF has been encouraging countries to move toward greater transparency and fuller disclosure; and will strengthen the standard as necessary.  It is already clear from the present crisis that we need better and more timely data on short term debt exposures, not only of banks, but also of corporations, as well as on some off-balance sheet activities of central banks.

Strengthening domestic financial systems and setting standards of good practice

The IMF, with other international organizations, has been working in this direction by helping to develop and disseminate a set of best practices in the banking area. These standards are codified in the Basle Committee's 25 core principles. IMF surveillance will play an important role in ensuring that the standards are met.

Efforts are also being made to set standards of good practice in related areas. The IMF will assist in the establishment and dissemination of various international standards including such areas as accounting, auditing, disclosure, asset valuation, bankruptcy, and corporate governance. The IMF will also help disseminate such standards to member countries and encourage their adoption through surveillance. Market participants would then have clearer basis for making their lending decisions. One thought here is that these standards would be better observed if the risk weightings on international loans applied by bank regulators in the lending countries reflected compliance of the borrowing countries with the standards.

Dealing with external debt problems

Considerable thought is being given to finding a way to involve the private sector in the resolution of financial crises in a timely way -- the ball-in question -- there is, however, no easy solution. Proposals that we need the equivalent of an international bankruptcy court or code, and that the international system needs to find a way to authorize a temporary stay on payments in an external financial crisis have been made. Formidable legal problems stand in the way of these solutions. Simple solutions of cessation of debt payments at times of crisis raises serious dangers of contagion. Involving the private sector in solving the problems of one country could lead to capital outflows from others with the consequence that the crisis spreads even if contained in the originating country. But the search for ways to deal with this problem must continue.

So what does all of this institutional and policy change at country, regional, and international levels mean for growth in Asia how does it renew prospects for growth? Perhaps the best way to think about this is to say that it can, to use a colloquial expression, increase the "bang for the buck." The globalization of the world economy saw an enormous and rapid increase in capital flows to emerging markets from $15 billion per year in the late eighties to $240 billion in 1996 and, particularly, to Asia. High domestic savings rates matched these capital flows. Yet despite Asia's amazing growth record, rates of growth fell short of expectations based on capital flows and domestic savings. In sum, Asias high growth over the past thirty years was expensive; the return for each dollar committed to investment was disappointingly low.

Weakness in intermediating capital flows and savings to high-return activities along with inadequate financial markets is at least part of the explanation of this expensive growth. These weaknesses could be related to unproductive government investment, directed bank credit, weak corporate governance, or to deficiencies in banking systems that lent too much based on connections than on the content of credit requests. Others point to narrow financial mattes minimal fixed income markets and equity markets that have limited coverage of the broader economy. These limitations meant that financial markets could not direct the high domestic savings to productive activities. The new policy and institutional structure emerging at national, regional, and international levels is starting to address these problems and should make investment more productive and reduce the downside risk of macroeconomic instability.

We should be under no illusions about how far Asia has to go but, within reach, is an even stronger Asian growth story than the one celebrated before July 1997. The new Asia will certainly build on the strengths of the past that resulted in spectacular growth of per capita incomes and made major inroads into alleviating poverty. But, stronger national, regional, and international economic relations will encourage more effective resource utilization and promote sustainable economic growth. The reward is clear and attainable for those countries that reform. The IMF-supported reform programs in Asia are not austerity programs. True, these programs respond to the reversal of capital flows but, at their core, they build on macroeconomic stabilization by promoting more efficient resource allocation through a new role for Asian governments. This role for government is to build the market infrastructure in financial, corporate and social sectors. Supporting these efforts, the recognition of mutuality of interest evident in the new regional surveillance arrangements is a positive development that can help prevent crises in the future. These actions sound national economic policy and international monetary cooperation are the core of the IMF's task as well as signify the challenges and opportunities facing Asia's economies.