IMF mission head recalls tough choices, good cooperation

That summer I was between jobs. I had just completed an intensive period working on another emerging market, Hungary, in the Fund's European department, and was looking forward to starting a more reflective type of job on India in the IMF's Asian Department. That was not to be.

The call from my new boss, Anoop Singh, was to tell me about the dramatic events unfolding in Thailand. The baht had been floated and the Thai authorities had asked for an IMF mission. He was on his way to Bangkok and wanted me to join his team. He had the sense that this was going to be a far more serious problem than we were accustomed to, and that it would be imperative to have someone on the ground in Bangkok to act as a channel of communications between the fund and the Thai authorities. Would I please move to Thailand - right away?

Uprooting a young family - I had two small children aged one and three at the time - and transporting them half way round the globe at such short notice was a daunting prospect. However, some seven years earlier, my wife and I had spent a wonderful month in Thailand and had fallen in love with the country and its people. So, the decision to move to Thailand was an easy one despite the many practical difficulties.

The early days in Bangkok were a blur of practicalities - finding a home, setting up a new office, and so on - and acclimatising to the new professional challenges of being thrown into a financial-banking system crisis. Through the whirl of events and welcoming new faces, what I recall most vividly is the pervasive mood of pessimism, gloom and self-doubt. Looking back, I now see my years in Thailand as an education of how a country and a people can rise above a seemingly hopeless situation.

One has to look back to the origins of the crisis to appreciate its severity and the extremely difficult job the Thai authorities had in dealing with the crisis. Much has been written about fiscal and monetary policy choices made during the early phases of the Asian crisis, but when I look back to the two years I spent in Bangkok, I see most macroeconomic issues paling in comparison to the importance of financial-sector policies and reform. A little background may help to clarify both how important these issues were and how difficult the policy environment was.

Roots of the crisis

It is often forgotten that the signs of fragility - the first tremors of the earthquake of July 2 - were apparent well before the summer of 1997. At the epicentre were growing doubts about the health of the financial system. Earlier that year, there had been official announcements of problems in finance companies. The extent of the "problems", however, was downplayed, and only later did it become public knowledge that as many as 66 finance companies had secretly received liquidity support in the first half of 1997.

The fact that prudential and provisioning regulations lagged international best practice added to the perception of hidden problems. For example, while international best practice for suspension of overdue interest on bad loans is three months, Thai financial institutions could accrue interest that they never actually received for as long as 12 months. There was much speculation and outright fear about the health of the financial system. As spring turned to summer, investors' fears were validated by the emergence of more and more problems in the financial sector. (Table 1)

The growing crisis of confidence led to significant capital outflows and pressure on the baht which the Thai authorities were not ultimately able to resist, despite massive exchange-market intervention.

The key response

It was against this backdrop that the international community, through the IMF, provided substantial support to rebuild depleted reserves. On August 14, 1997, the IMF board approved a three-year standby arrangement in support of the Thai authorities' efforts. The cornerstone of Thailand's programme was financial-sector reform, not only because the weaknesses in that area were at the root of the crisis but also because re-establishing banking-system soundness was viewed as critical for restoring macroeconomic stability.

The crucial link between the financial sector and macroeconomic stability was the exchange rate, which was also viewed by the public as the key barometer of confidence. There were good reasons for this. Both the financial institutions and the corporate sector had large foreign-currency liabilities. The depreciating baht was putting stress on balance sheets and threatening the viability of both financial institutions and private firms.

To add to the complications, at the outset of the crisis there was very little data on the currency composition, maturity structure, and counter parties to the external obligations of banks and corporations. This made it extremely difficult to predict the size and nature of the capital outflows or think about how private obligations could be refinanced. It took several months of enormous effort by the Bank of Thailand to put together a good data set to enable analysis of this issue.

Difficult choices

Thai policymakers faced an extremely difficult and complex situation in the aftermath of July 2, 1997. While it was clear that the financial-sector weaknesses had to be tackled and the exchange rate stabilised, achieving these objectives was not easy.

The options to stabilise the exchange rate where limited. Intervention prior to July 2 had not only failed to arrest the fall in the baht, but had drained existing reserves. A debt moratorium for a successful open economy was not an appealing option for Thai policymakers. While a few select capital controls were put in place, monetary policy seemed the most viable policy tool. Of course there was a limit to using interest rates as there was concern about corporate balance sheets, the impact on public-debt service costs, and the overall effect on domestic demand.

The key seemed to lie in decisive action to address the financial-sector weaknesses. Until the early 1990s, the IMF was not very experienced in financial-sector crisis management. Fortuitously, in the aftermath of the Nordic banking crisis, the fund had decided to enhance capacity in this area and had hired several experienced experts. These men and women were soon dispatched to the Asian crisis countries.

In developing a strategy to handle the unfolding crisis in the financial sector, Thailand was fortunate in two respects. First, it had a wealth of financial-sector experts capable of patiently piecing together data to understand problems and think about solutions. Second, just as the situation in the banking sector appeared to be getting worse, a superb economic team was installed that included the then finance minister Tarrin Nimmanahaeminda, and the then Bank of Thailand governor MR Chatu Mongol Sonakul. Of course, many other economic leaders, such as the then governor Chiayawat Wibulswasdi and the then minister Thanong Bidaya, plus Amaret Sila-on and Vicharat Vichit-Vadakan at the Financial Restructuring Authority, MR Pridiyathorn Devakula at AMC/EXIM, just to name a few, also provided important contributions.

Key landmarks

Looking back, there were some key steps which I believe were important in stabilising the financial sector and gradually restoring confidence.

An important one was putting in place a credible blanket guarantee on bank liabilities. The severity of the confidence crisis necessitated this measure. It was also key in sustaining depositors' and creditors' confidence in the viability of the core banking system. The transparent and independent process for assessing the viability of the finance companies was another important plank of the reform. Finally, the impressive financial sector restructuring plans put in place at the outset of the crisis on October 14, 1997, and a second wave of reforms announced on August 14, 1998, played an important part in bringing the banking system back to health.

These initiatives were in many ways innovative and provided the blueprints for reforms in other countries. The strategy of announcing a blanket guarantee and similar measures to the August 14, 1998, reform plans formed the cornerstone of actions that helped address the banking crisis in Turkey, where I was to work subsequently.

A great deal has been written about fiscal and monetary-policy choices during the crisis, but the reality is that the core of the discussion and analysis actually focused on understanding and resolving the banking-system distress that was at the root of the crisis. There is also a mythology about the IMF involvement. My memory of those days on the ground in Bangkok is that there was common agreement on what needed to be done to resolve the crisis, and fund staff, international experts, and Thai officials and policymakers worked together to reverse the crisis of confidence that gripped Asia.

I learned a lot from working with Thai officials at all levels and formed many friendships with both the well-known and the lesser-known heroes of the crisis. I was always impressed by their daily effort and dedication. Their hard work laid the basis for the strong recovery that is enjoyed today.

Moghadam is the head of the office of the managing director at the International Monetary Fund. After working in Bangkok as the IMF's first resident representative, he became head of the IMF's Indonesia division and later led the mission to Thailand. After working in Asia, he became the fund's mission chief to Turkey.