Journal of the Asia Pacific Economy

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The Asian financial crisis: Causes, dynamics,

prospects

Walden Bello

To cite this article: Walden Bello (1999) The Asian financial crisis: Causes, dynamics, prospects,
Journal of the Asia Pacific Economy, 4:1, 33-55, DOI: 10.1080/13547869908724669

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 THE ASIAN FINANCIAL CRISIS

Causes, dynamics, prospects

Walden Bello

Abstract Since mid-1997 East Asia, which had long been acclaimed as the
driving force of the global economy, has been wracked by financial turmoil.
The international policy response has been led primarily by the International
Monetary Fund with the full support of both the United States government
and the European Union. Those who predicted that IMF policy prescriptions
would quickly bring the Asian economic crisis under control have seriously
underestimated the depth of the recession that has hit the region. This paper
offers an explanation of the causes of the crises and, in doing so, provides a
critique of the international policy response. It begins with an examination
of the way that the crisis exemplifies the terminal collapse of Southeast Asia's
fast-track development model through case studies of Thailand and the
Philippines. The second part offers a critical analysis of the IMF policies which
have not only institutionalized stagnation in the region but have been used
overtly by the Clinton administration (and the EU by default) to promote the
trade and investment objectives of the leading states in the global economy.
The third part examines the implications of IMF-directed structural adjust-
ment and suggests that with the strategic withdrawal of capital, East Asia may
be on the threshold of a prolonged era of recession. The conclusion argues
that the very severity of the crisis demands the serious consideration of a
range of alternative political and economic strategies that will be essential for
the pursuit of a model of sustainable development in the future.
Keywords East Asia, economic crisis, capitalism, IMF, United States,
development.

INTRODUCTION
From the European Union's (EU) point of view, the overriding reason for
pushing the formation of the Asia-Europe Meeting (ASEM) in the early
1990s was so that the EU would not 'lose out on the economic miracle
taking place in Asia' (CEC 1994). American and particularly Japanese
capital already had a commanding position in the East Asian region and
continued to flow in in massive quantities. Unless European investment
came into Asia and trade expanded between the two regions, Europe was

Journal of the Asia Pacific Economy 4(1) 1999:33-55

R 1354-7860 © Routledge 1999

33
 WALDEN BELLO

headed for a geo-economic debacle. We can only wonder what is going on

in Brussels today in the way of a reassessment in the light of the financial
crises that have swept through the region. For what has happened, in light-
ning fashion, since mid-1997, is that from being the much-acclaimed driver
of the world economy in the twenty-first century, East Asia, or at least a very
significant part of it, has become a source of global financial turmoil.
The international policy response to the crises has primarily been led by
the International Monetary Fund (IMF) with the full backing of the Clinton
administration. The governments of Thailand, Indonesia and South Korea
each agreed to a structural adjustment programme whose terms were
designed to ensure that the targeted countries open themselves more fully
to international business as well as give priority to earning the foreign
exchange necessary to pay international debts. The essential instruments
for the project of neoliberal adjustment are already in place. In this context,
the EU has offered largely uncritical support for the IMF's actions. It was
able to use the second ASEM summit in London, in April 1998, to persuade
Asian leaders that stability would return if the stricken countries pursued
their IMF reform programmes with vigour. In this regard, the summit
issued a special separate statement on the economic crises which included
pledges on maintaining open markets and stressed the central role of the
IMF in 'reforming' the international financial system (ASEM 1998; Finan-
cial Times 1998c). The terms of the new dialogue between Asia and Europe
have completely changed in just two years and they have, at the same time,
narrowed the scope for serious debate about the future of the East Asian
region.
Yet the need for fresh thinking about alternatives to the free market trans-
formations exemplified by the IMF policy prescriptions has never been so
urgent as today. With events still moving rapidly, there is an obvious risk in
advancing full-blown theories about the new conjuncture in East Asia.
Nevertheless, this paper does attempt a coherent explanation of the causes
of the crises and, in doing so, provides a critique of the international policy
response. It begins with an examination of the way that the crisis exempli-
fies the terminal collapse of Southeast Asia's fast-track development model,
in particular, by focusing on case studies of Thailand and the Philippines.
The second part offers a critical analysis of the policy response of the IMF
which, it is argued, is not only institutionalizing stagnation in the region but
is being used overtly by the Clinton administration (and the EU by default)
to promote the trade and investment objectives of the leading states in the
global economy. The third part examines the implications of the general-
ization of IMF-directed structural adjustment and suggests that with the stra-
tegic withdrawal of capital East Asia may be on the threshold of a prolonged
era of recession. The conclusion argues that the very severity of the crisis
demands the serious consideration of a range of alternative political and
economic strategies that, while they have been largely absent from official
34
 THE ASIAN FINANCIAL CRISIS
policy discourse, will be essential for the pursuit of a model of sustainable
development in the future.

THE SOUTHEAST ASIAN COLLAPSE

Since the second half of 1997 Southeast Asia has been gripped by an econ-
omic crisis from which there seems to be no relief. A year on from the out-
break of the crisis the economic indices made stark reading: the Indonesia
rupiah had lost 82 per cent of its dollar value, the Thai baht about 42 per
cent, the Malaysian ringgit 38 per cent and the Philippine peso more than
34 per cent; in the same period stock markets fell, in dollar terms, by 89 per
cent in Indonesia, 73 per cent in Malaysia, 71 per cent in Thailand and 57
per cent in the Philippines (Wolf 1998b). Governments throughout the
region were paralysed by the crisis. In the case of Thailand, the ruling coali-
tion lost its last ounce of credibility as people looked toward the curious
combination of the King and the IMF for salvation in these frightening
times. In the Philippines, the former Ramos administration was reduced to
telling the people to count their blessings because the crisis was worse in
Thailand and Malaysia. And in Indonesia the crisis was directly responsible
for the fall of Suharto's New Order regime in May 1998.
In the case of all the Southeast Asian countries the crisis was triggered by
the rush of international capital out of the region in 1997 - a movement
that was more frenzied than its mad rush to get into the area in earlier years.
The pendulum swing is illustrated by figures from the Institute of Inter-
national Finance which show net private inflows into Indonesia, Malaysia,
South Korea, Thailand and the Philippines jumping from $40.5 billion in
1994 to $92.8 billion in 1996, then changing into a $12 billion outflow in
1997 (Wolf 1998a). Even Stanley Fischer (1997: 4), the deputy managing
director of the IMF, has conceded that in the case of the Asian financial
crisis,' [mjarkets are not always right. Sometimes inflows are excessive, and
jometimes they may be sustained too long. Markets tend to react fast, some-
times excessively'.

Anatomy of a model of 'fast-track' capitalism

[t would, however, be simplistic to paint the region as being simply a
victim of external forces. For the elites of Southeast Asia, in particular,
had institutionalized a pattern of development that was greatly dependent
on huge infusions of foreign capital. As The Nation (1997c) newspaper in
Bangkok put it,' [w] hen Southeast Asia jumped on the global bandwagon,
it should have been prepared for the downs as well as the ups'. Indeed,
unlike the case of growth in the classical newly industrializing countries
(NICs) of Taiwan and South Korea, the 'fast-track capitalism' of 7-10 per
cent GDP growth rates pursued by Southeast Asian technocrats was
35
 WALDEN BELLO

sustained not principally by domestic savings and investment but by

foreign investment.
The first phase of this process occurred between the mid-1980s and early
1990s, when a massive inflow of capital from Japan occurred, lifting the
region out of recession, and triggering a decade of high growth. This was
a consequence of the Plaza Accord of 1985, where the United States forced
the Japanese drastically to raise the value of the yen relative to the dollar in
order to relieve the US trade deficit with Japan. The agreement did not do
wonders for the US trade deficit but, by making production in Japan more
expensive in dollar terms, it forced the Japanese to seek out low-cost pro-
duction sites in the region, touching off a decade of rapid growth. Between
1985 and 1990 some $15 billion in Japanese direct investment flowed into
the region in one of the largest and swiftest movements of capital to the
developing world in recent history. This infusion brought with it not only
billions more in Japanese aid and bank capital but also an ancillary flow of
capital from the first-generation NICs of Taiwan, Korea and Hong Kong.
By the early 1990s, however, Japanese direct investment inflows were lev-
elling out or, as in the case of Thailand, falling off. The challenge con-
fronting the political elites and economic managers of Southeast Asia was
how to bridge the massive gap between the limited savings and investments
of the ASEAN countries and the massive investments they needed for their
strategy of 'fast-track capitalism' that, in their view, would bring about the
happy union of prosperity for them, development for all, and political sta-
bility. A second source of foreign capital opened up in the early 1990s. This
was the vast amounts of personal savings, pension funds, corporate savings
and other funds that were deposited in mutual funds and other investment
institutions that sought to maximize their value by placing them in highly
profitable enterprises. These funds were largely American. In the early
1990s, as an Asian Development Bank report noted, 'the declining returns
in the stock markets of industrial countries and the low real interest rates
compelled investors to seek higher returns on their capital elsewhere'
(Tang and Villafuerte 1995: 10).
These funds were not, however, going to come in automatically, without
a congenial climate. To attract these funds, financial managers throughout
Southeast Asia devised similar approaches, strategies that had the same
three key elements. First, there was the policy of financial liberalization, or
the elimination of foreign exchange and other restrictions to the inflow and
outflow of capital. This fully opened up stock exchanges to the participation
of foreign portfolio investors, allowing foreign banks to participate more
fully in domestic banking operations, and opening up other financial
sectors, like the insurance industry, to foreign players. Second, managers
sought to maintain high domestic interest rates relative to interest rates in
the US and other world financial centres, in order to suck in speculative
capital that would seek to capture the spread between, say, returns of 5 to
36
 THE ASIAN FINANCIAL CRISIS

6 per cent in New York and 12 to 15 per cent in Manila or Bangkok. And
third, the strategy was underpinned by fixing the exchange rate between
the local currency and the dollar to eliminate or reduce risks for foreign
investors stemming from the fluctuations in the value of the region's 'soft
currencies'. This guarantee was needed if investors were going to come in,
change their dollars to pesos, baht or rupiah, play the stock market, or buy
high-yielding government bonds, and transform their capital and their
profits back into dollars and move to other markets.
Of course, the mix of financial liberalization, interest rate policy and
exchange rate policy was different in different countries, and it was greatly
nuanced by the variations in other factors such as inflation and recession.
But the thrust in the manipulation of these policy tools was in the same
general direction. This policy was wildly successful in achieving its objective
of attracting foreign investment and finance capital. The Americans, in par-
ticular, were heavy players, with US mutual funds supplying net new capital
to the region in the order to $4 to $5 billion a year for the first half of the
1990s (Business World 1997).

Siamese twins: Thailand and the Philippines

In the case of Thailand, net portfolio investment or speculative capital
inflow came to around $24 billion, while another $50 billion came in the
form of loans via the Bangkok International Banking Facility (BIBF) which
allowed foreign and local banks to make dollar loans at much lower rates
of interest than those on baht loans. With the wide spread - some 600 to
700 basis points - between US interest rates and interest rates on baht loans,
local banks could borrow abroad and still make a clean profit relending to
local customers at lower rates than those charged to baht loans. Thai banks
and finance companies had no problems borrowing abroad. With the ulti-
mate collateral being an economy that was growing at an average rate of 10
per cent per annum - the fastest in the world in the decade 1985-95 -
Bangkok became a creditors' market. As one business commentator put it,
With the country's positive outlook, competition to lend to Thai
banks and finance companies has been intense . . . [and] as a result
of stiff competition, pricing levels in some cases are not presented
entirely in the financial fundamentals of the borrower. Many banks in
Asia are anxious to develop good relations with their Thai counter-
parts, and are increasingly willing to lend to build relationships rather
than to make money.
(Asiamoney 1995: 16)
The massive inflow of foreign capital did not alarm the World Bank and the
IMF, though short-term debt amounted to $41 billion of Thailand's $83
billion foreign debt by 1995. In fact, the Bank and the Fund were not gready
37
 WALDEN BELLO

bothered by the conjunction of skyrocketing foreign debt and burgeoning

current account deficit which came to 6-8 per cent of GDP in the mid-
1990s. As late as 1994, the official line of the World Bank on Thailand was:
Thailand provides an excellent example of the dividends to be
obtained through outward orientation, receptivity to foreign invest-
ment, and a market-friendly philosophy backed by conservative
macro-economic management and cautious external borrowing poli-
cies. Indeed, as late as 1996, while expressing some concern with the
huge capital flows, the IMF was still praising Thai authorities for their
'consistent record of sound macro-economic management policies'.
(Chote 1997: 16)
While the IMF 'recommended a greater degree of exchange rate flexibility',
there was certainly no advice to let the baht float freely.
The complacency of the Bretton Woods institutions when it came to Thai-
land — indeed, their failure to fully appreciate the danger signals - is traced
by some analysts to the fact that it was not incurred and financed by the
government but by the private sector. Indeed, the high current account
deficits of the early 1990s coincided with the government running budget
surpluses. As a group of perceptive Indian analysts noted, '[p]art of the
reason for this silence was the perception that an external account deficit
is acceptable so long as it does not reflect a deficit on the government's
budget but "merely" an excess of private investment over private domestic
savings'. In this view, countries with significant budget deficits, such as India
in 1991, were regarded as profligate even when their current account deficit
was lower than Thailand's. The latter's deficit, because it was not incurred
by government and not financed by public expenditures, was simply reflect-
ing 'the appropriate environment for foreign private investment radier
than public or private profligacy' (Ghosh et al. 1996: 2779).
Turning to the Philippines, Manila's technocrats were in the early 1990s
very hungry for foreign capital since the country had been, for reasons of
political instability, skirted by the massive inflow of Japanese investment
into the Southeast Asian region in the late 1980s. Eager to join the front
ranks of the Asian tigers, the Philippine technocrats saw Bangkok as a
worthy example to follow and in the next few years, in matters of macro-
economic strategy, the Philippines became Siam's twin. Cloned by Manila,
the formula of financial liberalization, high interest rates and a virtually
fixed exchange rate, attracted some $19.4 billion worth of net portfolio
investment into the country between 1993 and 1997. And dollar loans via
the Foreign Currency Deposit Units (FCDUs) - Manila's equivalent of the
BIBF - rose from $2 billion at the end of 1993 to $11.6 billion as of March
1997. As one investment house put it, with the peso 'padlocked' at 26.2 to
26.3 to the dollar since September 1995, 'they are not fools in Manila. They
were offered US dollars at 600 basis points cheaper than the peso rates
38
 THE ASIAN FINANCIAL CRISIS

along with currency protection from the BSP [the central bank]. They took
it' (HG Asia 1997).
Had these foreign capital inflows gone into the truly productive sectors
of the economy, like manufacturing and agriculture, the story might have
been different. But they went instead principally to fuel asset-inflation in
the stock market and in property which were seen as the most attractive
areas in terms of providing high yield with a quick turnaround time. In fact,
the predictable boom in property acted to siphon away capital from manu-
facturing in Thailand and the Philippines, as manufacturers, instead of
ploughing their profits into upgrading their technology or the skills of their
workforce, gambled much of them in property or stock market speculation.
The inflow of foreign portfolio investment and foreign loans into property
led to a construction frenzy that has resulted in a situation of massive over-
supply of residential and commercial properties from Bangkok to Jakarta.
In Bangkok, at the end of 1996, an estimated $20 billion worth of new resi-
dential and commercial property remained unsold, and yet building cranes
continued to dot the landscape as developers rushed new high-rises to com-
pletion. In Manila, the question is no longer if there is a glut in property.
The question is how big it will ultimately be, with one investment analyst
projecting that by the year 2000, the supply of high-rise residential units will
exceed demand by 211 per cent while the supply of commercial units will
outpace demand by 142 per cent (International Herald Tribune 1997).
Indeed, in their efforts to cut their losses in the developing glut, property
developers are now pouring billions into building resorts and golf courses!
All this has spelled bad news for commercial banks in Thailand, the
Philippines, Malaysia and Indonesia since they are heavily exposed in terms
of property loans. As a proportion of commercial banks' total exposure,
property or real-estate-related loans come to 15 to 20 per cent in the case
of the Philippines and Thailand, and 20 to 25 per cent in the case of
Malaysia and Indonesia. In Thailand, where the exposure in property is said
to be underestimated by official figures and is reckoned by some to come
to as high as 40 per cent of total bank loans, it is estimated diat half of the
loans made to property developers were 'non-performing', with the total
value of these loans estimated at between $3.1 billion and $3.8 billion (The
Nation 1997a).1

Stampede and speculation

Against this background the story unfolded quickly. It was the massive over-
supply in the property sector and the realization that many of Thailand's
finance companies that had borrowed heavily, floated bonds or sold equi-
ties to foreign portfolio investors and banks that made foreign investors
reassess their position in the country at the beginning of 1997. And they
panicked and began to move out when they saw the property glut in the
39
 WALDEN BELLO

context of the country's deteriorating macroeconomic fundamentals, such

as a current account deficit that came to 8.2 per cent of GDP (a figure
similar to Mexico's at the time of that country's crisis in December 1994),
an export growth rate of zero in 1996, and a burgeoning foreign debt of
$89 billion, half of which was due in a few months' time.
By early 1997, many investors concluded that it was time to get out and
to get out fast. With around $24 billion in baht parked in Thai stocks or
paper or nestled in non-resident bank accounts, the stampede was poten-
tially catastrophic (Baker 1996). This move to get out of Thailand meant
unloading trillions of baht for dollars, and with too many baht chasing too
few dollars, naturally the result was a tremendous downward push on the
value of the baht and tremendous pressure on the authorities to devalue it
officially relative to the dollar. This attracted the speculators - including
George Soros and his Quantum Fund - who sought to make profits from
the well-timed purchases and unloading of baht and dollars. The Bank of
Thailand tried to defend the baht at around 25 baht to one dollar by
dumping its dollar reserves on the market. But the foreign investors' stam-
pede that speculators rode on was simply too strong, with the result that the
central bank lost $9 billion in the spot market and another $23.4 billion in
forward swap commitments of its $39 billion reserves.2 With such massive
losses, the authorities threw in the towel and let the baht float to seek its
'true' market value on 2 July 1997.
The same drama was re-enacted in Manila, Jakarta and Kuala Lumpur,
where the same conjunction of commercial bank overexposure in the prop-
erty sector, weak export growth and a widening current account deficit was
stoking fears of a devaluation of the local currency that could devastate
their investments. As in Thailand, speculators rode on the exit of foreign
investors from these economies which accelerated tremendously after the
devaluation of the baht. The Philippine peso was floated on 11 July 1997,
followed by the Malaysia ringgit and the Indonesian rupiah over the next
month. These currencies plummeted in value as foreign capital continued
to exit, resulting in the catastrophic combination of rocketing import bills,
a massive rise in the cost of servicing the foreign debt of the private sector,
a steep hike in interest rates diat dampened economic activity, and a chain
reaction of bankruptcies. The Southeast Asian 'miracle' had come to a
screeching halt.

THE RESPONSE OF THE IMF

The IMF's record in the Asian region does not inspire confidence in the
institution. A number of reasons for this can be identified. First, the Fund,
by promoting a policy of indiscriminate capital account liberalization
among the East Asian economies, has been a central reason for the Asian
financial crisis. Second, the IMF has exhibited a remarkable inability to
40
 THE ASIAN FINANCIAL CRISIS

anticipate and to predict the financial crisis because it is imprisoned by an

economic paradigm that severely underestimates the destabilizing effects of
unregulated global capital markets. Third, the Fund is imposing stabiliza-
tion and recovery programmes that are worsening instead of alleviating the
economic crisis in the region, raising the spectre of a decade of stagnation,
if not worse. Fourth, the IMF is not so much restoring the East Asian
economies to health as bailing out the big international creditors. By not
allowing the latter to face market penalties, the Fund is practising what
many in Asia sarcastically term 'socialism for the global financial elite'.
Fifth, the Fund is being brazenly used by the Clinton administration as an
instrument to promote the bilateral trade and investment objectives of the
US, and, as witnessed at the second ASEM summit, it has been harnessed
by EU interests supporting Clinton's strategy to exert a global squeeze on
East Asian states. And finally, the IMF, for its own bureaucratic self-interest,
is preventing the Asian countries from developing innovative responses to
the crisis.

Indiscriminate capital account liberalization

It can no longer be denied that the Fund was central to the development
of the East Asian financial crisis. Two of the countries that are now in
trouble, Indonesia and Thailand, were, not too long ago, the two model
pupils of the Fund for following its prescriptions, particularly on capital
account liberalization. Until July 1997, Indonesia was consistently praised
for having liberalized its capital account as early as the 1970s, making it the
leader, in the view of the Fund and the World Bank, in Southeast Asian
financial reform. The Bank of Thailand was also put on a pedestal as a
model for central banks in the regions. The Bank of Thailand and the Thai
financial ministry were especially complimented by the Fund for carrying
out radical measures of liberalization in the early 1990s.
Let me focus initially on Thailand since it illustrates very clearly the
problem with the Fund and its prescription of indiscriminate capital
account liberalization. Prior to 1992, Thailand's financial system was highly
regulated (Vichyanond 1994). While foreign capital played a limited role
in the financial sector, the latter was also insulated from the highly desta-
bilizing inflows and outflows of unregulated portfolio investment and bank
capital. In 1992 and 1993, owing to IMF pressure, a set of radical deregula-
tory moves were carried out, which included: the removal of ceilings on
various kinds of savings and time deposits; fewer constraints on the port-
folio management of financial institutions and commercial banks; looser
rules on capital adequacy and an expansion of the field of operations of
commercial banks and financial institutions; dismantling of all significant
foreign exchange controls; and the establishment of the BIBF.
The BIBF was perhaps the most significant step taken by the Thais in the
41
 WALDEN BELLO

direction of financial liberalization. This was a system in which local and

foreign banks were allowed to engage in both offshore and onshore lending
activities. BIBF licensees were allowed to accept deposits in foreign cur-
rencies and to lend in foreign currencies, both to residents and non-resi-
dents, for both domestic and foreign investments. BIBF dollar loans soon
became the conduit for most foreign capital entering Thailand, which came
to about $50 billion between 1993 and 1996. With liberalization of the stock
exchange, net portfolio investment also escalated rapidly, so that by late
1996, there was some $24 billion in hot money circulating around in
Bangkok parked in stocks, corporate paper or in non-resident bank
accounts. This was a massive amount of money entering - in a very short
period of time — a country which had no experience in handling such an
infusion.
What both the IMF and its Thai pupils failed to foresee was that while the
liberalized capital account would be the conduit for huge capital inflows
when there was confidence in the country, it would also be the wide
highway through which capital would flee at the slightest sign of trouble.
And, indeed, this is what happened in 1997, when billions of dollars exited
in panic, bringing down the currency and the whole economy in the
process.

Blindsided by ideology
Thailand's financial crisis was about two years old before it attracted global
attention with the dramatic devaluation of the baht on 2 July 1997.
However, it cannot be said that either the IMF or its sister institution, the
World Bank, were worried about the possible consequences of the massive
inflows of foreign capital in the form of portfolio investments and loans
contracted by the Thai private sector. At the height of the borrowing binge
in 1994, the World Bank's line on Thailand in its annual report was:
Thailand provides an excellent example of the dividends to be
obtained through outward orientation, receptivity to foreign invest-
ment, and a market-friendly philosophy backed up by conservative
macro-economic management and cautious external borrowing poli-
cies.
(World Bank 1994)
As for the Fund, as late as the latter part of 1996, while expressing some
concern with the huge capital inflows, it was still praising Thai authorities
for their 'consistent record of sound macroeconomic management poli-
cies' (Chote 1997: 16).
The complacency of the Bretton Woods institutions, as noted earlier,
stemmed from the assumption that the massive capital inflows were fine so
long as they were incurred by the private sector and not by the government
42
 THE ASIAN FINANCIAL CRISIS

to fund the latter's deficit spending. Indeed, the high levels of debt of the
mid-1990s coincided with the government running budget surpluses or very
slight deficits. In the IMF's view, that the country's debt skyrocketed from
$21 billion in 1988 to $55 billion by 1994 and to $89 billion by 1996, was no
cause for alarm because it was mainly the private sector that was contract-
ing the debt. In 1996, the private sector accounted for 80 per cent of Thai-
land's external debt. In other words, the market would ensure that
equilibrium would be achieved in the capital transactions between private
international creditors and investors and private domestic banks and enter-
prises. So not to worry.
As we now know, leaving things to unregulated market forces led to a situ-
ation whereby massive amounts of capital went, not to productive invest-
ment in manufacturing or industry, but to high-yield areas with a quick
turnaround time, like property, car financing and massive credit creation.
The consequent massive oversupply of property triggered not a simple cor-
rection but a crash. That equilibrium would entail such a painful adjust-
ment owing to the irrationality of global capital markets was not something
that the Fund factored into the equation when it promoted radical finan-
cial market liberalization. This was a post-crisis realization, although the
Fund is now rewriting history saying that it had all along been warning the
Thai government of the consequences of the massive capital inflows.
But what is a matter of great surprise to most analysts in Asia is that,
despite the lessons of indiscriminate capital liberalization, the Fund's basic
solution to the financial crisis is for Asian countries to liberalize our capital
account and financial sectors even more. The solution is not just trans-
parency, as Fund officials are now fond of arguing. Greater government
regulation of capital flows, such as placing limits on bank exposure to prop-
erty or creating mechanisms to limit portfolio investment, is the crying
need. The Fund, however, has a negative view of such regulatory tools.

A cure worse than the disease

As many have already pointed out, the financial crisis in Asia is a crisis of
the market, of the private sector. Yet the solution of the IMF is to impose
the traditional Fund solution that addresses mainly a problem of severe
government indebtedness by cutting back on government expenditures
and requiring government to produce a surplus. The problem is also one
not of severe inflationary pressures, which is why another element of the
traditional IMF formula, raising interest rates, is questionable. The upshot
of the IMF formula is to add deflationary pressures that aggravate the reces-
sionary effects of the financial crisis instead of putting into motion counter-
cyclical mechanisms such as increased government capital expenditures
that would arrest the decline in private sector activity.
The aim of the IMF programme is supposedly to achieve what IMF
43
 WALDEN BELLO

bureaucrats see as the centrepiece of the programme: the return of foreign

capital. This is the reason why they defend in particular the maintenance
of high interest rates. There are two problems with this. First, a programme
of recovery demands a more diverse platform than just waiting for foreign
investors to return. As a fund manager of American Express International
has said with respect to the IMF programme in Thailand: 'The only card
the government has to play right now is the return of foreign investors. It's
disconcerting that everything rests on the return of foreign investors'
(Bangkok Post 1998b). Second, even granting that focusing on the return of
foreign investors alone is a valid strategy, how on earth are they expected
to return and make profitable investments in an economy where one is
engineering a deep recession?
The dangers of imposing the wrong solution are evident in Thailand.
Growth forecasts have been steadily downgraded as demand slumped,
export recovery remained elusive and the credit squeeze continued. At the
time of the IMF programme in August 1997, the projected GDP growth rate
for 1998 was 2.5 per cent. By the time of the first IMF review in early Decem-
ber, after the government began to put into effect the deflationary
measures demanded by the IMF, the projection for the GDP growth rate
was lowered to 0.6 per cent. By the time of the next IMF review in Febru-
ary 1998, GDP growth was projected at a negative 3.5 per cent; and by mid-
1998 the Institute of International Finance forecast a contraction of some
7 per cent (Financial Times 1998d).
That the Fund's regimen had helped trigger a freefall was admitted by
Hubert Neiss, the IMF's Asia Pacific director, who said that 'the economy
had slowed down to such an extent that a continued austerity regime may
prompt a new economic crisis' (Bangkok Post 1998a). The IMF was forced
to make a slight concession, which was to allow the government to run a
budget deficit of 1-2 per cent of GDP instead of insisting on the original
demand to achieve a 1 per cent surplus, but the slight positive effects of this
move are likely to be neutralized by the IMF's continuing insistence on high
interest rates. In this connection, it must be noted that this is not the only
instance that an IMF programme has accelerated the crisis: the IMF admit-
ted in an internal memo that its directive to the Indonesian government to
shut down sixteen insolvent banks precipitated a run on two-thirds of the
country's banks, throwing the country's financial sector into a shambles
(New York Times 1998a).
Not surprisingly, owing to the Fund's lack of concern about the way high
interest rates are making survival difficult for local firms, some of Asia's
business groups increasingly see IMF programmes as geared towards soft-
ening the resistance of local firms to takeovers by foreign investors. Also
people in Asia cannot understand why Washington and the IMF are
encouraging the Japanese to engage in more government spending,
provide tax cuts and keep interest rates low, when they are prescribing
44
 THE ASIAN FINANCIAL CRISIS

exactly the opposite to the rest of East Asia, in response to the same region-
wide crisis.

Building a safety net for the global financial elite

While squeezing local businesses, the IMF programmes are serving as a
safety net for the big Japanese, European and American banks that have
made irresponsible lending decisions. And in this regard, it must be stressed
that European banks collectively are more exposed in East Asia than Japan-
ese banks, who are in second place, and American banks.
To clarify matters, we can focus once more on Thailand. 'Financing the
balance of payments deficit', which is one of the key purposes of the IMF
package for Thailand, is a broad canopy that covers servicing the debt of
Thailand's private sector. The IMF-assembled funds of $17.2 billion provide
an assurance that the government will be able to address the immediate debt
service commitments of the private sector, while it is trying, with the support
of the IMF, to persuade creditors to rollover or restructure their loans (IMF
1997). The programme dius repeats the pattern of the IMF-US Mexican
bailout in 1994 and the IMF structural adjustment programmes during the
Third World debt crisis in the 1980s, in which public money from Northern
taxpayers was formally handed over to indebted governments, only to be
recycled as debt service payments to commercial bank creditors.
There is something fundamentally wrong about a process that imposes
full market penalties on the Asian private sector while sparing international
private financial institutions - indeed, socializing the latter's losses. Asian
critics are not asking the IMF to bail out our firms; they are simply asking
for a sharing of the market's punishment for making the wrong decisions.
As the Thai newspaper, The Nation (1997d), puts it:
The penalties imposed on foreign creditor banks which have lent to
the Thai private sector must be precise and applied equally — Thai-
land and Thai companies may bear the brunt of the financial crisis
but foreign banks must also share part of the cost because of some
imprudent lending. It would be irresponsible to lay the blame entirely
on Thailand.
To exempt the international banks from market penalties will encourage
them to continue in irresponsible lending - and here it must be noted that
during the mid-1990s the international banks were often the ones scram-
bling to lend to Thailand.

The US's window of opportunity

A golden opportunity to push the US agenda opened up with the financial
crisis, and Washington has exploited it to the hilt advancing its interests
45
 WALDEN BELLO

behind the banner of free market reform. The Clinton administration has
made it clear that it will use the IMF to push the US bilateral economic
agenda with East Asia. In the case of Thailand, for instance, the authorities
have agreed to remove all limitations of foreign ownership of Thai finan-
cial firms and are pushing ahead with even more liberal foreign investment
legislation that would allow foreigners to own land, a practice that has long
been taboo in the country. As the US Trade Representative, Charlene
Barshefsky, sees it, 'commitments to restructure public enterprises and
accelerate privatization of certain key sectors - including energy, trans-
portation, utilities, and communications - which will enhance market-
driven competition and deregulation [are expected] to create new business
opportunities for US firms' (Barshefsky 1998). In Indonesia, Barshefsky has
underlined that the IMF's conditionalities
address practices that have long been the subject of this Adminis-
tration's bilateral trade policy.... Most notable in this respect is the
commitment by Indonesia to eliminate the tax, tariff, and credit priv-
ileges, provided to the national car project. Additionally, the IMF
program seeks broad reform of Indonesian trade and investment
policy, like the aircraft project, monopolies and domestic trade
restrictive practices, that stifle competition by limiting access for
foreign goods and services [ibid.].
Indeed, so frank have the administration's statements been in this regard
that the Financial Times (1998a) has reported that US officials have told
their 'domestic audience that they will use the opportunity provided by the
crisis to force radical structural reform on other countries that would
amount to what some critics see as an "Americanisation" of the world
economy'.
Summing up Washington's strategic goal, without having to use the
euphemisms of his former colleagues in the administration, Jeff Garten, the
Undersecretary of Commerce during Clinton's first term in office, has said
that the countries of East Asia 'are going through a deep and dark
tunnel.... But at the other end there is going to be a significantly differ-
ent Asia in which American firms have achieved much deeper market pen-
etration, much greater access' (New York Times 1998b). The significance of
the second ASEM summit in this regard was that the EU, partly inspired by
concerns for the exposure of European banks, has signed up to the same
agenda.

Monopolizing solutions
While Washington and the EU have not hesitated to exploit the situation for
its own ends, Japan has missed a golden opportunity to move decisively into
the role of Asia's economic leader. In fact, the Asian countries did produce
46
 THE ASIAN FINANCIAL CRISIS

in alternative institution and process to stabilize the financial situation in

the region in August 1997. The alternative approach came in the form of
the Japanese proposal to establish the 'Asian Monetary Fund' (AMF). The
Fund, with a possible capitalization of $100 billion (all of it drawn from Asian
countries) was envisioned as a multi-purpose fund that would assist Asian
economies in defending their currencies against speculators, provide emer-
gency balance-of-payments financing, and make available long-term funding
for economic adjustment purposes. As oudined by the influential Ministry
of Finance official Eisuke Sakakibara, the Fund would be a quick-disbursing
mechanism that would be more flexible than the IMF by requiring 'a less
uniform, perhaps less stringent, set of policy reforms as conditions for receiv-
ing help'. The AMF had the backing of all the Asian countries, with Taiwan
and China being on the same side for once (Altbach 1997).
Not surprisingly, the IMF managing director, Camdessus, and his deputy,
lTischer, argued against the establishment of the AMF, as did the US
administration. The stated rationale was that the AMF would subvert the
IMF's ability to secure tough economic reforms from Asian countries. The
reality was that the AMF would threaten the IMF's monopoly on the making
of policy for dealing with the financial crisis. The Clinton administration,
i
vithout consulting Congress, backed the IMF leadership and 'made con-
siderable efforts to kill Tokyo's proposal'. One of the key reasons is that,
ivith Congress's increasing assertiveness in foreign economic policy using
its power of the purse, the Clinton administration sees the IMF as an
increasingly important instrument to push key initiatives without having to
submit them to Congressional oversight.
Faced with the administration's opposition, the Japanese government
backtracked and eventually allowed the AMF to be watered down during a
meeting of Asian finance ministers' in Manila in November 1997 into a
vaguely defined mechanism to supplement the IMF, whose central role in
stabilizing the region financially was affirmed. The Japanese retreat has left
ihe region's elites with litde choice but to accede to IMF conditionalities.
In Korea, the newly installed president, Kim Dae-Jung, promised full com-
pliance with the IMF programme, with some of his advisers reportedly offer-
ing to better the IMF demand that a maximum of 55 per cent foreign
ownership of Korean firms to 100 per cent (Business Week 1998a). In Indone-
sia, former president Suharto clashed with the IMF, but strangely enough
not on the question of loosening the stringent IMF conditionalities, but on
his insistence on an 'IMF-plus' proposal of pegging the rupiah to the dollar
and tying the amount of rupiah in circulation to the amount of the
country's dollar reserves. In Thailand, compliance with a deflationary IMF
programme that was expected to produce a negative growth rate of-3.5 per
cent in 1998 won the new government of the prime minister, Chuan
Leekpai, the compliment of having 'turned the corner' in the effort to
restructure the economy (Neiss 1998).
47
 WALDEN BELLO

IMPLICATIONS OF THE CRISIS

Strategic withdrawal
Despite statements made by some Southeast Asian governments that the
crisis is a short-term one — a phase in the normal ebb and flow of global
capital - there is a strategic withdrawal of finance capital from the South-
east Asian region. The new darlings of the fund managers are Latin Ameri-
can markets, which rose almost 40 per cent on average in 1997 as Asian
markets fell. As the Financial Times (1997) points out, Brazilian equities,
which have risen by 70 per cent in the first half of the year, look very good
to fund managers. So do Russian equities, which have more than doubled
since the start of 1997, and Chinese 'red chips', which have gone up by 90
per cent. But one thing is certain, foreign capital is not likely to return to
Southeast Asia anytime soon. Most likely is the scenario of prolonged crisis
laid out by the chairman of a key player in the Asian investment scene,
Salomon Brothers Asia Pacific. US mutual funds, he said, which had been
supplying net new capital to the region of $4 to $5 billion a year, were now
pulling out owing to the bleak investment outlook. The currency instabil-
ity would last from seven to twelve months, if the earlier experiences of
Mexico, Finland and Sweden were any indication, during which there
would be weak domestic demand and 'severe contraction in GDP in some
of them' (Business World 1997).

Will FDI also fly?

A second consideration is the question: Will foreign direct investors follow
the lead of the banks and portfolio investors and pull their capital out of
the region? With the slow growth in the region's exports and the spread of
deflationary tendencies, new foreign investors are likely to be deterred
from making significant commitments, and Ford and General Motors,
amongst others, are now probably regretting their 1996 decision to set up
major automobile assembly plants in Thailand to churn out cars for what
was then seen as an infinitely growing Southeast Asian market. It is not
clear, however, how Japanese direct investors will react. Some analysts say
that new investment flows from Japan are not likely to be reduced that
much since the Japanese are continuing to pursue a strategic plan of
making Southeast Asia an integrated production base. In Thailand alone,
it is pointed out, more than 1,100 Japanese companies are ensconced and
only a massive economic downturn can reverse the momentum that has
built up. As one Japanese executive asserted, 'It [Japanese investment] is a
long-term strategy where investments are increased on a year-to-year basis,
so I don't think a 10 to 20 per cent devaluation will force Japanese investors
to change their investment strategies for Thailand' (The Nation 1997b).
48
 THE ASIAN FINANCIAL CRISIS

However, there is a new wrinkle to the situation that makes the position
different from the early 1990s. First of all, Japanese investment strategies in
the last few years have targeted Southeast Asia not just as an export plat-
form for third-country markets but increasingly as a group of prosperous
middle-class markets to be themselves exploited — and these markets are
expected to contract severely. Second, diverting production from Southeast
Asian markets to Japan will be difficult since Japan's recession, instead of
giving way to recovery, as expected in early 1997, is becoming even deeper,
with an astounding 11 per cent decline in GDP on an annualized basis.
Finally, redirecting production to the US is going to be very difficult, unless
the Japanese want to provoke the wrath of Washington, which is already
warning Japan not to 'export its way out of its recession' and is increasingly
responsive to claims from US manufacturers that the Southeast Asian
economies' trade surpluses with the US are really mainly trade surpluses
registered by Japanese companies that have relocated to the region - imply-
ing that they must be added to Japan's official trade surplus with the US.
The upshot of all this is that Japan could be burdened with significant over-
capacity in its Southeast Asian manufacturing network, which could trigger
a significant plunge in the level of fresh commitments of capital. Develop-
ments like these can only deepen and prolong the regional recession.

Liberalization: advancing or retreating?

A third key consideration relates to the question of whether the crisis will
result in an advance or in a retreat of economic liberalization. While many
Asian economic managers are now coming around to the position that the
weak controls on the flow of international capital have been a major cause
of the currency crisis, US officials and economists are taking exacdy the
opposite position: that it was incomplete liberalization that was one of the
key causes of the crisis (Friedman 1997). The fixing of the exchange rate
has been identified as the major culprit by Northern analysts (HG Asia
1996), conveniently forgetting that many portfolio investors had empha-
sized the stability that fixed rates brought to the local investment scene.3
Not even the IMF had advocated a truly free float for Third World curren-
cies owing to its fears of the inflationary pressures and other forms of econ-
omic instability this might generate. But the agenda of the US has been
bigger than advocacy of the freely floating currency, and this includes the
accelerated deregulation, privatization and liberalization of trade in goods
and services in a part of the world which many American corporations
regard as one of the world's most protectionist and government-managed
in economic orientation.
Formerly, die economic weight of the Southeast Asian countries enabled
them to successfully resist Washington's demands for faster trade liberaliz-
ation. Indeed, they were able to derail Washington's push to transform the
49
 WALDEN BELLO

Asia-Pacific Economic Cooperation (APEC) forum into a free trade area

(Bello and Chavez-Malaluan 1996). But with the changed situation, this may
no longer be possible, and Washington may work via the IMF to complete
the liberalization or structural adjustment of the economies where the
process was aborted (with the significant exception of financial liberaliz-
ation) in the late 1980s owing to the cornucopia of Japanese investment.
Indeed, even without prodding from Washington, in their desperate desire
to keep foreign capital in the country, the Thai authorities have removed
all limitations on foreign ownership of Thai financial firms and are pushing
ahead with even more liberal foreign investment legislation to allow for-
eigners to own land. Jakarta has abolished a 49 per cent limit for foreign
investors to buy IPO shares in publicly listed companies (Pereira 1997).
Under IMF tutelage, the Philippines is already the most structurally
adjusted country in East Asia, and Thailand is now in the process of being
radically liberalized by the IMF. Indonesia has also joined the IMF queue,
and though Mahathir has vowed Malaysia would never to go to the IMF,
many wonder how long he can hold on this stance.
What this means is that with the generalization of IMF-directed structural
adjustment, Southeast Asia may be on the threshold of an era of minimal
or low and fluctuating growth such as that which characterized Latin
America and the Philippines in the period 1980-93, when they underwent
fairly comprehensive and thorough adjustment programmes at the hands
of the World Bank and the IMF.

CONCLUSIONS: CRISIS . . . AND OPPORTUNITY?

So dominant has free market ideology become in international elite dis-
course - including the ASEM process — that even its opponents in govern-
ments and business mouth its platitudes while opposing it in practice. It is
mainly reformers outside governing circles, in non-governmental organiz-
ations (NGOs) or in the academic community, that are voicing alternatives
to the free market transformation of East Asia that has now entered a more
advanced stage. Although not yet 'operationalized' in a hardheaded
fashion, their agenda is getting an increasingly sympathetic hearing from
the public, especially at a time that the US-IMF-ASEM reforms are associ-
ated with rocketing inflation and mass unemployment that exceeded 10 per
cent in 1998.
What are some of the key themes of this alternative programme? First of
all, one of the prime causes of the current crisis has been the indiscrim-
inate globalization of financial markets. Controls are badly needed on
capital inflows and outflows since they are proving to be highly destabiliz-
ing to developing economies. The call for controls is, of course, hardly
unconventional these days, when even Alan Greenspan, the chairman of
the US Federal Reserve Board, has suggested that the world financial system
50
 THE ASIAN FINANCIAL CRISIS

must be 'reviewed and altered as necessary to fit the needs of the new global
environment' (Financial Times 1998b). From the perspective of Asia's
reformers, however, capital controls are needed not just for purposes of
stability but to be able to manage the development process in a healthy
direction, as a way of discriminating against the entry of speculative capital.
Very popular among reformers in the region today is some version of the
so-called 'Tobin Tax' (named after its proponent, the US economist James
Tobin), a transactions tax imposed on all cross-border flows of capital that
are not clearly earmarked as direct investment. Such a measure would, it is
claimed, help to slow down the frenzied and increasingly irrational move-
ments of finance capital. A slowing down of the movements of speculative
capital would also be accomplished by a measure used by the Chileans and
advocated by Southeast Asian experts: require portfolio investors to make
an interest-free deposit of an amount equal to 30 per cent of their invest-
ment that they would not be able to withdraw for one or more years. This
would make them think twice before pulling out at the scent of higher
yields elsewhere. The aim is not to discourage foreign direct investment.
Such measures would create a strong disincentive for speculative capital to
arbitrarily enter and exit, with all the destabilizing consequences of this
movement, but would not penalize direct investors that are making more
strategic commitments of their capital. Foreign direct investment (FDI), of
course, brings with it its own problems, and it must be managed by a related
system of incentives based on, among other considerations, the strategic
objective of acquiring technology.
Second, while FDI of the right kind is important, growth must be
linanced principally from domestic savings and investment. This means
good, progressive taxation systems. One of the key reasons for the reliance
on foreign capital for 'fast-track' development was that the elites of South-
east Asia did not want to tax themselves to produce the needed investment
capital. Regressive taxation systems are the norm in the region, where
income tax payers are but a handful and indirect taxes that cut deeply into
uhe incomes of the poor are the principal sources for government expen-
diture. But progressive taxation wouldjust be the start. Democratic manage-
ment of national investment policies is also essential if local savings are not
1:0 be hijacked by financial elites and channelled into speculative gambles.
A third theme is that while export markets are important, development
must be reoriented around the centrality of the domestic market as the
main stimulus of development. Together with the excessive reliance on
foreign capital, one of the negative lessons of the crisis is the consequence
of the tremendous dependence of the regions' economies on export
markets. In the view of reformers, this has only led to extreme vulnerabil-
ity to the vagaries of the global market and sparked a regional and inter-
national race to the bottom that has beggared significant sectors of the
labour force while only really benefiting foreign investors and the small
51
 WALDEN BELLO

domestic manufacturing elite. A strategy of enlarging the domestic market

to generate growth must include a more comprehensive programme of
asset and income reform, including effective land reform. There is in this,
of course, the unfinished social justice agenda of the progressive movement
in Asia - an agenda marginalized by the regnant ideology of growth during
the 'miracle' and largely ignored in international responses to the crises.
Vast numbers of people remain marginalized because of grinding poverty,
particularly in the countryside. Land and asset reform would simul-
taneously bring them into the market, empower them economically and
politically, and create conditions for social and political stability. Achieving
economic sustainability based on a dynamic domestic market can no longer
be divorced from issues of equity.
A fourth theme addresses the very central issue of what would serve as
the organizing principles of the economy. The fundamental mechanism of
production, distribution and exchange will have to be something more sen-
sible and rational than the 'invisible hand' of the market. Certainly, the
state is essential to curb the market for the common good, but in East Asia
the state and the private sector have traditionally worked in non-trans-
parent fashion to advance the interests of the upper classes and foreign
capital. While not denying that market and state can play an important and
subsidiary role in the allocation of resources, the emerging view is that the
fundamental economic mechanism must be democratic decision-making
by communities, civic organizations and people's movements. The chal-
lenge is how to operationalize such institutions of economic democracy.
The search for the 'third way' is associated with the increasing importance
of NGOs in society, and the way they are perceived and perceive themselves
as a 'fiscalizer' of both government and the market in an evolving system
of checks and balances.
There are, of course, other elements in the alternative development
thinking taking place in the region but one universal theme is 'sustainable
development'. The centrality of ecological sustainability is also said to be
one of the hard lessons of the crisis. For the now discredited model of
foreign capital-fuelled high-speed growth has left behind litde that is posi-
tive and much that is negative. In place of 8—10 per cent growth rates, many
environmentalists in the region are now talking of rates of 3—4 per cent.
This links die social agenda with die environmental agenda, because one
reason for high growth rates was so that elites could corner a significant
part of economic growdi while still allowing some growth to 'trickle down'
to die lower classes for the sake of social peace.The alternative - redistri-
bution of wealth - is clearly less acceptable to the ruling groups, but it is
die key to a pattern of development that combines economic growdi, politi-
cal stability and ecological sustainability.
These ideas and others remain to be welded together into a coherent
strategy, and diat strategy in turn awaits a mass movement to carry it. The
52
 THE ASIAN FINANCIAL CRISIS
emergence of such a movement must not be underestimated. One clear
lesson of the crisis is that the region's elite are anachronistic. They will
fight their displacement - as Suharto tried to do - but the drastic loss of
legitimacy stemming from their economic mismanagement provides a
window of opportunity for progressive movements to translate their ideas
into effective political strategies for change. Frozen during the years of the
long boom, mass politics with a class edge is about to return to the centre-
stage.

Focus on the Global South, Bangkok

Received: June 1998

NOTES
1 See also the internal memo of an investment firm requesting anonymity, 'Of
currency crisis and financial stability in South East Asia', 18 September 1997.
2 Losses on the spot market refer to actual losses incurred by the Bank of Thailand
in the sale of foreign exchange to prop up the value of the baht on a daily basis.
Forward swap obligations refer to agreements to honour currency exchange
transactions maturing at a certain date at a certain rate of exchange. These trans-
actions are said to be 'hedged', i.e. the rate agreed upon is a less favourable rate
of exchange (from the perspective of the weaker currency) than the present rate
to protect the holders of the weaker currency from a possibly even more unfavour-
able rate of exchange dictated by market developments.
3 As one investment analyst saw it, the combination of a completely open border
to financial flows and an informally fixed exchange rate was a deadly com-
bination. 'Throughout the period, Thailand's borders have . . . remained open
to international capital flows and this introduces an obvious question to a Thai
borrower - if he can borrow US dollars much more cheaply than baht and if the
BOT [Bank of Thailand] protected him against currency risk, why should he
borrow in baht?' (HG Asia 1996).

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