Sección o Parte de un Documento 1995 es 382.3 B584L(58739) Corden, W. Max Coediciones NAFTA AMERICA LATINA LIBERALIZACION DEL INTERCAMBIO NEGOCIACIONES COMERCIALES TRATADOS ZONAS DE LIBRE COMERCIO FREE TRADE AREAS LATIN AMERICA TRADE LIBERALIZATION TRADE NEGOTIATIONS TREATIES NAFTA Una zona de libre comercio en el Hemisferio Occidental: posibles implicancias para América Latina Incluye Bibliografía En: La liberalización del comercio en el Hemisferio Occidental - Washington, DC : BID/CEPAL, 1995 - p. 13-40 Proyecto Apoyo al Proceso de Liberalización Comercial en el Hemisferio Occidental http://hdl.handle.net/11362/1510 2014-01-02T14:51:16Z 2014-01-02T14:51:16Z Made available in DSpace on 2014-01-02T14:51:16Z (GMT). No. of bitstreams: 0 Previous issue date: 1995 POLÍTICA COMERCIAL Y ACUERDOS COMERCIALES TRADE NEGOTIATIONS COMERCIO INTERNACIONAL E INTEGRACIÓN INTERNATIONAL TRADE AND INTEGRATION Texto Documentos de proyectos , / V /% f BiBÜOTF.CA , - V- K0YU¡ - h iA C 0 - -: c: ; íi!,O A S \n S A M TíA G O ■ V ?^ h , CHi Macroeconomic adjustments and the real economy in Korea and Malaysia since 1997 Zainal-Abidin Mahani Kwanho Shin Yunjong Wang N A C IO N E S U N ID A S C E P fl L MACROECONOMIC ADJUSTMENTS AND THE REAL ECONOMY IN KOREA AND MALAYSIA SINCE 1997 Zainal-Abidin Mahani Kwanho Shin Yunjong W ang LC/W.7 October 2004 This document was prepared by Kwanho Shin, Professor at the University of Korea; Yunjong Wang, Investigator at the Korea Institute for International Policy (KIEP); and Zainal-Abidin Mahani, Professor at the University of Malaysia, within ECLAC research project on M anagem ent o f Volatility, Financial G lobalization an d Growth in EEs, supported by the Ford Foundation. The authors gratefully acknowledge Ricardo Ffrench-Davis for detailed comments on the earlier and revised draft. Also, they wish to thank Ariel Buira, Roy Culpeper, José de Gregorio, Barry Herman, Manuel Montes, José Antonio Ocampo, Arturo O’Connell, John Williamson, Heriberto Tapia, and other participants o f two seminars organized by ECLAC, for their useful suggestions and comments on the revised version. The authors alone are responsible for all opinions expressed in this paper. Contents A bstract........................................................................................................................................................................ 5 Introduction................................................................................................................................................................. 7 1. Post-crisis m acroeconom ic adjustments in Korea and M alaysia......................................................... 9 a) K orea................................................................................................................................................................. 9 b) M alaysia......................................................................................................................................................... 17 2. P olicy responses for crisis resolution..........................................................................................................25 a) P olicy responses in K orea......................................................................................................................25 b) P olicy responses in M alaysia................................................................................................................... 31 3. A ssessm ent o f the adjustment processes in Korea and M a la y sia ...................................................... 37 4. P olicy im plications........................................................................................................................................... 45 R eferences................................................................................................................................................................. 47 ECLAC/Ford Foundation research project: docum ents pub lished..........................................................49 Serie inform es y estudios especiales: issues published............................................................................... 51 Tables Table 1 Table 2 Table 3 Table 4 Short-term foreign currency liabilities o f the financial sector in K orea..................... 9 Korea: Selected econom ic indicators, 1 9 9 6 -2 0 0 2 ............................................................12 Malaysia: End-of-year stock o f volatile capital and foreign exchange reserves, 1 9 9 0 -9 7 ...................................................................................................18 Malaysia: Selected econom ic indicators, 1 9 9 6 -2 0 0 2 ..................................................... 20 Figures Figure Figure Figure Figure 1 2 3 4 Changes in G DP shares o f expediture com ponents......................................................... 39 Growth rates o f expenditure com ponents........................................................................... 40 M onetary variables (three month inter-bank lending rate)............................................42 Inflation and unem ploym ent rates........................................................................................ 43 3 Abstract This p a p e r review s the post-crisis m acroeconom ic adjustm ent and the im pact o f p o licy responses on the real econom y in the R epublic o f K orea an d M alaysia. While both countries suffered under the Asian fin an cial crisis, an d initially both a pplied restrictive policies, subsequently their p o licy responses w ere quite different in several respects. K orea sought liquidity assistance from the IMF, which o b lig ed it to im plem ent a structural adjustm ent program , while M alaysia w as able to recover po licy independence in the p ro cess o f crisis resolution. Korea and M alaysia a dopted p o licies diam etrically contrasting p o licies on capital flo w s in response to the crisis. Korea drastically liberalized its capital account (however, keeping some restrictions on capital outflows by residents) with a floatin g exchange rate regim e (although with a huge accumulation o f reserves during recovery), while M alaysia im posed stringent capital controls and returned to a fix ed (but devalued) exchange rate. However, both countries, to fa c e recession in 1998, m ade a sw ift change tow ard an expansionary m acroeconom ic p o licy stance, ba sed on a vigorous expansive fisc a l policy. This contributed to an econom ic recovery notably fa ste r than in oth er EEs. The p ositive role o f counter-cyclical m acroeconom ic p o licies in post-crisis recovery raises the question o f w hether the initially tight m onetary and fisc a l p o licy w as kept f o r too long and, therefore, deepen ed the crisis in K orea and M alaysia. The experience o f these two econom ies, and their management o f the afterm ath o f the crisis appears to be extrem ely relevant f o r LACs. 5 INTRODUCTION The financial crisis that broke out in Thailand in July 1997 and then spread to other parts o f East A sia brought about a deep recession, causing a sharp decline in living standards, rising unem ploym ent, industrial breakdown, and social dislocation in the region (Park and W ang, 2002). In 1997-98, five East Asian countries -Indonesia, Korea, M alaysia, the Philippines, and T hailand- experienced sharp currency and banking crises. Although a few other East Asian countries were affected to a lim ited extent, the A sian financial crisis w as region-w ide.1 Korea and M alaysia have managed im pressive recoveries at remarkable speed, as compared to other emerging econom ies. These econom ies started to bottom out in the second half o f 1998 and then show ed a remarkable turnaround in 1999. W hile the real G DP growth rates o f Korea and M alaysia were -6.7% and -7.4% in 1998, they rebounded to 10.7% and 6.1%, respectively, in 1999. This paper aims to review the post-crisis m acroeconom ic adjustment and the impact o f p olicy responses on the real econom y in Korea and M alaysia. W hile both countries suffered under the A sian financial crisis, their policy responses were quite different. Korea sought liquidity assistance from the IMF, w hich obliged it to com ply with the IM F’s structural adjustment program, w hile M alaysia was able to maintain policy independence in the process o f crisis resolution. Korea and M alaysia adopted policies at opposite extrem es in terms o f capital market opening in response to the crisis. For exam ple, Korea drastically liberalized its capital account with a free floating exchange rate regim e, w h ile M alaysia im plem ented m ore stringent capital controls w ith a return to a fixed exchange rate regim e. D espite the different p olicy stances in terms o f capital account and exchange rate regim e, the sw ift change toward an expansionary m acroeconom ic p olicy stance helped the two econom ies recover quickly. The positive role o f counter-cyclical m acroeconom ic policies in the post-crisis recovery raises the question o f whether the initial tightening o f monetary and fiscal p olicy was kept high for too long and as a consequence deepened the crisis in both Korea and M alaysia.2 This case study highlights the dynam ics o f the m acroeconom ic adjustments that cam e w ith responses such as monetary, fiscal, and exchange rate p olicies and the effects o f those policies on variables such as capital formation and output, o f the real econom y. This comparative analysis w ill provide policy im plications to the question o f what p olicy responses w ill be m ost effective in dealing with future crises. Section 1 focuses on post-crisis m acroeconom ic adjustments in Korea and M alaysia. Section 2 review s policy responses for crisis resolution in Korea and M alaysia. Section 3 1 The Singapore and the New Taiwan dollar experienced a relatively small depreciation. During the crisis, no significant devaluation took place in China, which remained relatively insulated from world financial markets. 2 As an initial response to the crisis, Malaysia followed the orthodox IMF policy prescriptions without the IMF involvement -nam ely, tightened fiscal and monetary policies, introduced measures to redress the balance of payment weakness, and floated the exchange rate. 7 assesses the adjustment process in Korea and M alaysia and compares both cases. Section 4 concludes with som e remarks on p olicy im plications. 1. Post-crisis macroeconomic adjustments in Korea and Malaysia a) Korea i. W hat c a u sed the crisis? The crisis in Korea was certainly unexpected, perhaps more so than in m ost other crisishit East A sian countries. A s late as June 1997, the W orld E conom ic Forum had classified Korea as the fifth m ost secure place to invest in the world (A gosin, 2001). At the onset o f the financial crisis, the m acroeconom ic fundamentals o f Korea appeared to be sound. H owever, the Korean miracle w as suddenly unraveled. Actually, Korea was vulnerable to a financial crisis because o f its large exposure to short-term external liabilities (Radelet and Sachs, 1998; Rodrik and V elasco, 2000). Korea’s external debt increased dramatically over the three-year period o f 1994-96. The major portion o f the increase in external debt involved the financial sector. For instance, foreign currency liabilities o f Korean Banks nearly tripled in that period, to U S$ 104 billion. Tw o sources contributed to the increase in the financial sector’s external debt: one w as debt securities that were issued abroad, w hile the other w as external borrowing by the dom estic financial institutions. Out o f the total increase in external debt during the three years, the financial sector accounts for about 70%. The remaining 30% reflects growth in the external debt o f the corporate sector. In fact, short-term foreign currency liabilities o f the dom estic financial institutions were much larger than reflected in capital inflow s. A s part o f the liberalization measures (which cannot be captured explicitly in terms o f capital account liberalization), banks were allow ed to open and expand operations o f overseas branches. B y exploiting the foreign capital channeled through overseas branches, banks actively engaged in foreign currency denominated business. About half o f the foreign currency operations o f the banking sector was handled by overseas branches and, therefore, their transactions were not reflected in dom estic monetary indicators (see table 1). M oreover, the m anagement o f foreign currency liquidity risks at the individual bank level w as not adequate enough to forestall the liquidity crisis, either. Table 1 Short-term foreign currency liabilities of the financial sector in Korea (US$, billion) 1992 1993 1994 1995 1996 1997 11.3 11.4 19.4 29.7 39.2 27.4 18.5 21.1 28.0 33.4 39.0 20.3 Total 29.8 32.5 47.4 63.1 78.2 47.7 Foreign reserves 17.1 20.2 25.6 32.7 33.2 20.4 Short-term external debt Short-term liabilities of overseas branches Source: Bank of Korea. 9 A huge part o f ex cessiv e short-term external liabilities can be explained by asymmetric regulations on short-term borrowing vis-à-vis long-term borrowing. The government boosted incentives for short-term debts by m aking it mandatory to provide detailed information and obtain perm ission from the regulatory authorities in the case o f long-term borrowing, whereas short-term borrowing w as regarded as trade related financing and therefore not strictly regulated under the Foreign Exchange M anagem ent Law. Thus, banks and firms had been operating on a long-term basis with short-term foreign borrowings, leading to a significant discrepancy in the maturity structure (K im et al.. 2001). Furthermore, the maturity m ism atch w as more serious for merchant banks.3 For exam ple, the liquidity ratio in foreign currency for merchant banks w as only three to six percent for all the period up to the financial crisis. Thirty merchant banks becam e heavily engaged in offshore operations by borrowing cheap short-term Japanese funds from H ong K ong to finance m ostly long-term investm ent projects. W ith 80% short-term debts put into 70% long-term assets, the maturity m ism atch blew up w hen K orea’s credibility plum meted. Pressured to obtain foreign currency to repay their debts, merchant banks ultim ately ended up buying foreign currency on the spot market with w on-denom inated call loans from com m ercial banks. Furthermore, those merchant banks were not properly supervised. Neither unified accounting standards nor standards for classifying non-perform ing loans existed, and supervision had been perfunctory at best. This lax supervision allow ed merchant banks to enjoy freedom without any discipline. W hen Korea embarked on the IMF structural adjustment program, merchant banks were the first to go through restructuring because their volum inous short-term external debts and imprudent investm ents were inconsistent with the custom ary practices o f the world financial market. ii. O verall m a cro eco n o m ic a n d se cto ra l p erfo rm a n c e The impact o f the financial crisis on the real econom y becam e apparent in the first quarter o f 1998 as G DP contracted b y 4.6% on a year-on-year basis. Throughout 1998, the deterioration o f m acroeconom ic conditions far exceeded the expectations o f both Korean policy makers and IM F econom ists. For exam ple, the second IM F agreement forecast that real G DP w ould fall by 1% or less in 1998, but it actually shrank 6.7%. D espite a relatively im pressive growth rate for exports (13.3% in dom estic currency value) in 1998,5 private consum ption, investm ent, and imports dramatically declined (see table 2). Non-tradable sectors, such as construction, were hit harder than the manufacturing sector, which is more trade-oriented. A s output contracted, unem ploym ent quickly increased from 2.1% in October 1997 to 8.7% in February 1999. The real w ages o f workers in the manufacturing sector fell by 11% in 1998. 3 Most merchant banks in Korea started as investment banks after the Decree of August 3, 1972, to provide legitimate channels to utilize black market funds. They were modeled after the British merchant banks but were also permitted to engage in the financing o f medium- and long-term equipment investment. Later in 1994 and 1996, the 24 existing investment banks were allowed to become merchant banks, joining the six existing ones. Several merchant banks, owned by chaebols, served as important vehicles for raising the funds required for the chaebols’ voluminous investments; these affiliate banks failed to conduct adequate loan assessments of their parent companies. 4 The Korean government suspended the operations o f the 14 unhealthiest merchant banks in December 1997. 5 In dollar terms, however, even exports recorded negative growth. 10 After a sharp contraction, the Korean econom y started to bottom out in the first quarter o f 1999. In 1999, real G DP growth recorded 10.7%, overshooting its pre-crisis average o f 7%. Growth was led b y buoyant private consum ption, a rebound in equipment investm ent, and a slow er pace o f inventory de-stocking. Due to the strengthening o f the econom y, the unem ploym ent rate sharply declined from the record level o f 8.7% in February 1999 to 4.4% in Novem ber 1999, w hile inflation remained low , notwithstanding depreciation. The sharp contraction and the rapid recovery o f Korea’s growth rate are broadly consistent with the V-shaped adjustment patterns observed in cross-country analyses. H owever, the magnitude o f initial contraction and the speed o f recovery in Korea are in sharp contrast with the stylized pattern. The margin betw een a 6.7% decline in 1998 and a 10.7% recovery o f GDP in 1999 is far greater than predicted by the cross-country evidence. M alaysia also experienced a huge jum p in G DP growth from a 7.4% decline in 1998 to a 6.1% recovery in 1999. One fundamental question relates to whether the output reduction after the A sian crisis was a temporary deviation downward from the trend level, w hich was eventually reversed as output reverted to trend, or alternatively, whether the level o f output tended to shift down permanently. Cerra and Saxena (2003) find that the recovery phase is predominantly characterized by a return to the normal growth rate o f an expansion. Thus, the level o f output is permanently low er than its initial trend path. A permanent loss is associated with a downward shift o f potential output, whereas a temporary loss is associated with a deterioration o f the output gapimportant structural factors driving the speedy adjustment in Korea were flexibility and openness (Park, 2001). W ith a relatively large trade sector oriented towards exports, Korea was able to benefit from a substantial depreciation o f the real exchange rate and fall in real wages. The labor market adjustments were less rigid than had been assumed. A s a consequence, a more dramatic adjustment took place in the manufacturing sector. The manufacturing sector recorded a large decline o f 7.4% in 1998, but quickly rebounded to record a growth o f 21.0% in 1999. On the other hand, the construction sector, a typical non-tradable, suffered a continuous recession in 1999. 11 Table 2 Korea: Selected economic indicators, 1996-2002 1996 1997 1998 1999 2000 2001 2002 6.8 5.0 -6.7 10.9 9.3 3.0 6.3 Consumption 7.2 3.2 -10.1 9.4 6.7 3.7 6.2 Private 7.1 3.5 -11.7 11.0 7.9 4.7 6.8 Indicators/year Growth of GDP (%) Growth by final demand category (%) 8.2 1.5 -0.4 1.3 0.1 1.3 2.9 7.3 -2.2 -21.2 3.7 11.4 -1.8 4.8 Agriculture, forestry and fishing 3.3 4.6 -6.6 5.4 2.0 1.9 -4.1 Industry 7.0 5.8 -6.1 11.0 9.8 3.8 6.7 -0.1 -0.9 -24.0 5.3 2.5 0.5 3.9 6.8 6.6 -7.4 21.0 15.9 2.1 6.3 6.9 1.4 -8.6 -9.1 -3.1 5.6 3.2 8.7 5.0 8.6 Government Gross fixed capital formation Growth by sector (%) Mining and quarrying Manufacturing Construction Services 7.5 6.5 -4.7 10.0 Unemployment rate 2.0 2.6 6.8 6.3 4.1 3.7 3.1 Consumer price 4.9 4.4 7.5 0.8 2.3 4.1 2.8 Producer price 3.2 3.9 12.2 -2.1 2.0 1.9 1.6 10.2 Inflation rate (%) Fiscal performance (central government) / 10.1 11.0 10.4 10.1 10.4 10.6 Budget surplus(central government) as % of GDP 0.3 -1.5 -4.2 -2.7 1.3 1.3 4.1 Total public debt as % of GDP 8.8 11.1 16.1 18.6 19.5 20.8 - 16.7 13.9 12.5 8.0 7.1 11.6 13.6 Annual average bank lending rate (%) 11.21 11.83 15.18 9.40 8.55 7.71 6.70 Overnight rate 12.36 13.24 14.98 5.01 5.16 4.69 4.21 4.1 6.0 7.4 8.3 6.6 2.9 2.3 833.4 654.5 406.1 806.8 734.2 572.8 757.0 Government expenditure as % of GDP Money and credit (end of period) M3 growth (%) Non-performing loans as % of total loans b/ KOSPI index External transactions Merchandise exports (US$, FOB billion) 130.0 138.6 132.1 145.2 175.9 151.3 162.6 Merchandise imports (US$, FOB billion) 144.9 141.8 90.5 116.8 159.1 137.8 148.4 6.1 Current account balance (US$, billion) -23.0 -8.2 40.4 24.5 12.2 8.2 Current account balance as % of GDP -4.4 -1.7 12.7 6.0 2.7 1.9 1.3 Capital account balance (US$, billion) -0.6 -0.6 0.2 -0.4 -0.6 -0.7 -1.1 Capital account balance as % of GDP -0.1 -0.1 0.5 -0.1 -0.1 -0.2 -0.2 Direct investment (US$, billion) -2.3 -1.6 0.7 5.1 4.3 1.1 -0.7 Portfolio investment (US$, billion) 15.1 14.4 -1.2 9.2 12.2 6.7 -0.1 Other investment (US$, billion) 11.1 -21.9 -7.2 -1.1 -3.6 -4.6 2.7 Foreign reserves (US$, billion) 34.0 20.4 52.0 74.0 96.1 102.8 121.3 Total external debt as % GDP 31.4 33.4 46.8 33.8 28.5 27.5 27.5 Short-term foreign debt as % of total debt Short-term foreign debt as % of foreign reserves 57.1 39.9 20.6 28.6 36.4 33.3 38.0 274.2 312.5 59.1 53.0 42.7 48.5 41.0 Source: The Bank of Korea, M onthly B ulletin ; Ministry of Finance and Economy, F inancial Statistics B ulletin ; Financial Supervisory Commission, IMF, International Financial Statistics. End of period. w Non-performing loans of domestic commercial banks. 12 iii. E xchange rate Thailand’s sudden decision to float the baht in July 1997 subjected all regional currencies to extrem ely high depreciation pressure. H owever, the Korean w on remained relatively stable until it began to slide in October 1997. F ollow ing futile attempts o f currency defense, the Korean governm ent w idened its w on trading band from 2.25% to 10% on N ovem ber, and finally abolished its band, allow ing the w on to float on Decem ber. W ith a free floating regim e in place, the sudden collapse o f investor confidence and concom itant capital outflow s caused the nom inal exchange rate to overshoot during the crisis. Large support packages by the IMF did make som e contribution to restoring the confidence o f foreign investors. The funding helped to reduce the short-term liquidity constraints o f the econom y and provided financial resources to contain the exchange rate depreciation. The Korean governm ent expected that its agreement with the IMF, reached on D ecem ber 3, 1997, w ould stop the outflow o f foreign capital. H ow ever, foreign banks withdrew their short-term credit at an accelerated pace, thereby worsening Korea’s foreign reserve position (see table 2). In response to this unfavorable developm ent, the Korean government asked the major creditor countries, including the U .S. and Japan, to use moral suasion to influence their creditors to refrain from retrieving their short-term credit, and cooperate in reaching an agreement to lengthen the maturity o f the short-term foreign currency loans. Only when foreign creditors were convinced that they w ould be repaid with handsome returns, were the debt-extension agreements signed and finalized on March, 1998.6 Thereafter, at least som e foreign credit facilities including trade credit was restored and the exchange rate cam e to stabilize at around 1,300-1,400 w on per U S dollar. iv. E q u ity m arket After hitting its highest level (1,138 points) on N ovem ber 8, 1994, the Korean stock price index (KOSPI) had already started sliding before the crisis broke out. This w as one o f the earliest signs o f trouble, although policy makers were inclined to believe that the declining stock prices were m ainly due to cyclical factors rather than w eak fundamentals. During 1996, stock prices (in dom estic currency terms) fell by more than 20% in Korea. Several o f the largest chaebols posted lo sses in 1996 and 6 o f the top 30 chaebols w ent bankrupt in 1997 before the crisis. The crisis aggravated the situation and severely undermined investor confidence in the stock market. A s a result, the stock price index fell to 376 points by the end o f D ecem ber 1997. Having hit the bottom, the KOSPI quickly recovered at the beginning o f 1998, with the aid o f purchases by foreign investors. H owever, after peaking at 574 points on March, 1998, the K OSPI once again began to slide downward. F ollow ing the sudden w eakening o f the Japanese yen, the KOSPI plunged below 300 points on June. Again, foreign investors left the Korean market, and m ore bankm ptcies were predicted w hile corporate and financial restructuring proceeded. Stock prices and exchange rates m oved in a predictable direction during the early crisis period (October 1997-D ecem ber 1997). A s the crisis set in, exchange rates sharply depreciated and stock prices plunged. H owever, stock prices fell again in March 1998 and 6 The Korean government was able to issue US$4 billion in global bonds, in the international capital market, immediately following the debt-extension agreement. 13 remained stagnant until the end o f September, w hile the won-dollar exchange rate stabilized remarkably. During the post-crisis period, starting in October 1998, foreign portfolio investm ent boosted stock prices in 1999, but stock prices sharply dropped in m id-2000 and 2001 (over 50% in index). W ith respect to exchange rates, continued foreign portfolio investm ent also contributed to the stability o f the exchange rate, but exchange rate appreciation w as lim ited because o f evident intervention o f the B O K .7 v. C u rre n t a ccount balance The current account deficit averaged less than 1% o f G DP in 1992-95 and the external position was considered sustainable. In real effective terms, the exchange rate had been around the equilibrium lev el until 1994, but was som ewhat overvalued on the eve o f the 1997 currency crisis.8 A remarkable feature o f Korea’s econom ic performance follow ing the crisis has been the large turnaround in the current account balance. It improved from deficit to surplus after one year, changing from -4.4% o f G DP in 1996 (U S$23 billion) to 12.7% in 1998 (U S $40 billion). The current account balance was the only com ponent that made a positive contribution to G DP in 1998. Imports o f goods and services were severely com pressed due to the sharp depreciation o f the Korean w on and the sharp contraction o f output and consum ption. Exports o f goods and services, how ever, rose in volum e terms by more than 13%, helped by improved external com petitiveness and the governm ent’s export drive.9 External demand, particularly in A sia, remained weak in 1998 and hampered the response o f Korean exports to the real depreciation. R eflecting the disparity in econom ic conditions between regions, exports to China, Japan, and Southeast A sia in 1998 fell by 17% in value terms, w hile exports to the U .S. and the E U rose by 6.5%. The strong U .S. econom y was a significant source o f growth for Korean exports in 1998, in particular for both light and heavy industrial products. M uch o f the decline in exports o f industrial products to Japan (m ainly in electronics and metal goods) w as redirected to the U .S. and to a lesser extent the EU. vi. C a p ita l flo w s The capital account adjustment w as also very sharp. Im m ediately follow ing the onset o f the crisis, the capital account sw itched from a surplus to a deficit as a result o f the large outflow 7 The Korean government has taken drastic measures to liberalize capital markets as well as adopting an officially flexible exchange rate system since the crisis set in. Thus, it would be natural to conjecture that if the Korean government truly has a hands-off policy in the foreign exchange market, there must be some close interaction between stock prices and exchange rates. However, Park et al. (2001) find that empirical results do not support that conjecture during the post-crisis period. This puzzling evidence indirectly hints that the Korean government might heavily intervene in the foreign exchange market against volatile foreign portfolio investment flows. This was strongly supported by the huge accumulation of reserves by the BOK. 8 Our calculation based on trade-weight, consumer prices index, and January 1993 as the basis year shows that the real effective exchange rate appreciated by around 5% in Korea between January 1993 and July 1997. 9 To help meet the urgent need for foreign exchange, a national drive to export second-hand goods and recycled gold jewelry was initiated in early 1998. Financial institutions collected gold products, refined and exported them, and then sold the foreign exchange proceeds to the Bank of Korea. The drive enjoyed widespread national support, and is estimated to have contributed about US$4.2 billion to total exports in 1998. 14 o f portfolio investm ent and curtailment o f short-term bank loans. The capital account show ed deficits o f up to U S $64 billion in 1998. After the crisis, the financing role o f the capital account for any current account im balances decreased (K im et al.. 2001). Starting in the first quarter o f 1999, the capital account registered a surplus led by strong inflow s o f portfolio and foreign direct investm ent, a decline in overseas investm ent by Korean com panies, and a slight pickup in short-term trade financing related to the econom ic recovery. In particular, FD I picked up sharply in 1998 as com panies began to rely increasingly on foreign capital to finance their corporate restructuring efforts. During the pre-crisis period including 1997, net FD I recorded a deficit. But, there w as an im pressive turnaround in the net balance of FDI as a com ponent o f the capital account. This w as due to the increased mergers and acquisitions o f Korean firms by foreign firms -supported by the governm ent p olicies aim ed at sellin g ailing dom estic firms to foreigners.10 W ith regard to portfolio investm ent, private equity flow s picked up markedly in the first half o f 1999 after international credit rating agencies raised Korea’s sovereign rating to investm ent grade. International spreads also cam e down to near pre-crisis levels in m id -1999 after a period o f extrem e volatility. W ith this developm ent, Korean com panies could raise capital from the international financial markets by issuing global depository receipts (GDRs). vii. F oreign reserves and extern a l debt After having fallen to a low o f U S $3.9 billion on Decem ber 18, 1997, foreign reserves increased steadily, reaching U S $48.5 billion by the end o f 1998. The increasing trend continued in 1999-2000: foreign reserves stood at U S $96.2 billion by year-end 2000. During the early period o f crisis resolution, the front-loaded disbursements from the A D B , IMF and W orld Bank, successful m aturity-extension agreement in March 1998, and successful issuance o f U S $ 4 billion o f global bonds in April 1998 contributed to the sizable reserve accumulation. N onetheless, the m ost important increase in foreign reserves closely corresponded to the current account surplus, absorbed by sterilized interventions o f the Bank o f Korea. Consequently, K orea’s external debt position did significantly improve. The ratio o f short-term debt to foreign reserves decreased from 714.6% in 1997, to 63.3% in l9 9 8 and to 53.0% in 1999, im plying that short-term debt could be covered by official foreign reserves. Total external liabilities during 1999 decreased by U $ $ 1 1 .6 billion from the previous year, w hile the total external assets increased by U S $16.9 billion. This handsome improvem ent transformed Korea’s external position; Korea went from being a net debtor in 1998 to being a net creditor in 1999. In terms o f debt maturity, the ratio o f short-term debt to the total stood at b elow 0.3 in 1999. W ith the strengthening o f reserve and external asset/liability positions, Korea accelerated its repayments to the IM F to fully settle its loans ahead o f schedule. 10 To induce FDI, all institutional restraints on mergers and acquisitions of domestic firms by foreign investors were completely abolished on May, 1998. 15 viii. Financial market Prior to the crisis, there was som e concern over the persistent expansion o f dom estic credit to the private sector at double-digit rates. D om estic credit increased from 57.4% o f nominal G DP in 1994 to alm ost 70% in 1997. It is possible that the credit supply has grown as usual w hile profitability o f the real sector was declining for reasons such as delayed adjustments o f non-perform ing com panies. In the pre-crisis period, there w as easier access to bank credit for firms associated w ith chaebols, w hile non-chaebol firm s’ access to bank credit w as more influenced b y market considerations (Borensztein and Lee, 2000). The relatively sm all chaebols (those ranked 11th to 30th) were significantly under-performing even during the 1994-96 boom period. W hen the terms-of-trade shock arrived in April 1996, the situation o f the highly leveraged corporate sector, apparently, was aggravated and the number o f defaults increased significantly far ahead o f the crisis. A s large chaebols went bankrupt, the financial sector began to bear a substantial burden. F ollow in g the decline in the H ong K ong stock market in late October 1997, and the downgrade o f K orea’s sovereign risk, financial markets in Korea cam e under increasingly severe pressure. A s in the other Asian crisis countries, with reserves essentially depleted, the choice w as made to raise interest rates to restore market confidence and stabilize the exchange market. B y Decem ber 24, the Bank o f Korea had dramatically raised short-term interest rates, w hich had fluctuated at around 12% prior to the crisis, to over 30% in order to engineer a rapid stabilization o f the exchange rate. H owever, there were a number o f malignant side effects accom panying the high interest rate p olicy along with financial sector restructuring. The contraction in bank loans w as extrem ely severe as a com bined result o f both monetary conditions and structural changes in the financial sector. Borensztein and Lee (2000) explain several factors, which affected the changes in the pattern o f credit allocation after the crisis broke out. First, financial institutions becam e more reluctant to extend loans to enterprises because o f the new financial sector regulations (enhanced financial standards) and high credit risks. In particular, som e banks did not m eet capital adequacy ratios and could not raise equity capital in tim es o f financial difficulties. Thus, they started to curtail credit to firms by a larger magnitude. Second, the higher level o f interest rates further w eakened the state o f borrowers’ balance sheets. In particular, highly leveraged corporate firms were m ore vulnerable to the interest rate hikes. The level o f non-perform ing loans rose from 13% o f G D P in D ecem ber 1997 to 22% by June 1 9 98.11 Third, the fiscal deficit increased from a sm all surplus in 1997 to a deficit o f over 4% o f GDP. Consequently, the traditional “crow ding-out” effect reduced credit available to the private sector as the government had to tap dom estic financial markets to a large extent. Fourth, as foreign credit lines dried out, banks had to repay their short-term foreign debts by curtailing dom estic credit. 1 In July 1998, there was a major revision o f loan classification standards and provision requirements, which 1 classified loans in arrears o f three months or more as substandard or below, and loans in arrears o f one to three months as precautionary loans. Asset quality classification standards were further implemented in 1999 by adopting the forward-looking criteria (FLC), which includes expected future performance into account as a criterion. Before July 1998, non-performing loans include loans in arrears of six months or more. 16 Once the imm ediate task o f stabilizing the exchange rate market w as accom plished in early 1998, the stance o f monetary p olicy w as cautiously eased. Since small and m edium -sized enterprises (SM Es) were hit harder by the effects o f the credit squeeze compared to larger firms, the Korean government took a number o f steps to ease the financing constraint for SM E s.12 b) M alaysia i. W hat c a u sed the crisis? In m id -1997, like the other affected econom ies, M alaysia did not expect to encounter a severe crisis although the econom y w as considered “overheated” due to the high growth registered during the 1990s. On 17 June 1997, Mr. M ichael Cam dessus, then M anaging Director o f the IMF, drew attention to the soundness o f the M alaysian econom y: “M alaysia is a good exam ple o f a country where the authorities are w ell aware o f the challenges o f m anaging the pressures that result from high growth and o f maintaining a sound financial system , amid substantial capital flow s and a boom ing stock market.” Inflow s o f short-term capital (m ainly portfolio investm ent) started to becom e significant in 1993, amounting to U S $9.5 billion (14% o f G DP), exceeding the inflow o f FDI (U S$5.1 billion). That inflow went m ainly to the stock market, w hich resulted in the super bull run o f the Kuala Lumpur Stock Exchange. The capital inflow w as also important in offsetting the current account deficit: at its peak in 1995, the current account deficit w as 10.4% o f GDP. B y 1997, the current account deficit w as still significant at 5.4% o f G DP, although this did not directly put a downward pressure on the ringgit exchange rate. R ising services account shortfalls and higher capital goods imports were the reasons for the persistent deficits. The large inflow o f portfolio investm ent had created a w indow o f vulnerability for the M alaysian econom y in the event o f a sharp, quick and large outflow . The stock o f portfolio capital had increased from U S $4.6 billion in 1990 to U S $36 billion in 1997, w hich meant that a large and uncontrolled withdrawal would do serious damage to the econom y and to the ringgit. Another vulnerable point for M alaysia was the seem ingly stable ringgit exchange rate. The large w eight o f the U S dollar in the currency basket (estim ated at about 70%) had indirectly created a de facto pegged exchange rate regim e for the ringgit. Even with the large capital inflow in the second half o f the 1990s, the ringgit was traded within a very narrow band at around RM 2.5 for one U S dollar. This exchange rate stability had given the im pression that there w as no risk associated with the flow s o f funds and subsequently attracted large short-term capital into M alaysia without the fear o f possible exchange rate losses. W ith sufficient international reserves to m eet foreign exchange demand, there w as little concern that M alaysia w ould confront an econom ic crisis when the baht w as floated in July 12 SMEs are defined as enterprises employing less than 300 workers in the manufacturing sector and 20 workers in the service sector. In order to ease financial difficulties o f the SMEs, the Bank of Korea raised the ceiling on total loans from KRW 3.6 trillion (in November 1997) to KRW 5.6 trillion (in February 1998). Further, the Bank of Korea overhauled the 90-day maturity clause on commercial bills, which qualify for discount (effective beginning May 1998). In addition, the government gave an extension of maturity o f loans, which are made out to SMEs. 17 1997.13 In 1997, M alaysia’s international reserves o f U S $28 billion were sufficient to cover the short-term debt o f U S $14 billion in 1997 (table 3). H ow ever, from another perspective, this level o f reserves w as insufficient to m eet the demands o f liquid capital, w hich was com posed o f a com bination o f short-term foreign debts and portfolio capital. H ence, the loss o f market confidence in the regional econom ies that resulted with the floating o f the baht, in particular about the sufficiency o f the international reserves, triggered a m assive outflow o f capital from the M alaysian stock market. The outflow o f private short-term capital reached U S $4 billion in 1997 and becam e even larger in 1998 at U S $5.3 billion. Table 3 Malaysia: End-of-year stock of volatile capital and foreign exchange reserves, 1990-97 1991 1992 1993 1994 1995 1996 1997° 6.3 6.5 12.4 23.9 27.7 31.9 38.9 50.1 100 100 100 100 100 100 100 100 1990 Mobile capital“7 US$ billion , Composition of mobile capital (%) 26 Banking sector (%) Non-bank private (%) 40 41 28 20 20 26 28 26 Short-term debtb/ (%) 40 41 28 14 14 18 22 0 0 0 0 6 6 8 6 72 Portfolio investment (%) 74 60 59 72 80 80 74 Foreign exchange reserves, US$ billion 10 11 19 30 26 26 28 28 158 171 149 124 94 80 72 56 Reserve/mobile capital ratio (%) Source: Athukorala (2001). 3 Short-term debt plus portfolio investment. 7 b Debt with a maturity of one year and less. d First half of the year. This outflow caused steep ringgit depreciation. Equally serious were the effects o f ringgit depreciation on the banking sector. The M alaysian banking sector had been relatively strong compared to the banking sectors in other countries in the region - in the m id-1990s, the average capital adequacy ratios for all banks in M alaysia remained above 10% (Athukorala, 2001) and the level o f non-perform ing loans w as 3.7% in 1996. D espite this strong position, the rapid credit growth had created areas o f w eakness because o f the concentration o f loans in selected non­ tradable sectors, in particular, to the property sector and for share purchases. This credit growth had a significant link to the share market boom as shares were used as collateral for these loans. Thus, when the value o f the shares decreased as the stock market collapsed, many o f these loans turned non-performing. W hen faced with the prospects o f a more fragile financial position, many banks began withdrawing loan facilities or dem anding more collateral. A s a result, businesses faced a credit crunch and higher cost o f funds, w hich culm inated in the contraction o f the econom y. ii. O verall m acro eco n o m ic a n d secto ra l p erfo rm a n c e Although the Asian crisis began in the m iddle o f 1997, its impact on the M alaysian econom y w as only felt in late 1997. G DP grew at a com m endable rate o f 7.3% in 1997 but the 13 Due to the prudential measures exercised by the Bank Negara Malaysia, there was no massive build-up of short­ term foreign borrowings. Malaysian companies are required to have a natural foreign exchange hedge before they are allowed to borrow overseas. Normally, the natural hedge means that the companies would have foreign currency income to service the loans. 18 econom ic contraction w as very deep at -7.4% in 1998 (table 4). This severe contraction was due to a com bination o f several factors: the deflationary force o f the regional econom ic slow dow n, m assive capital outflow s, public sector expenditure reduction and a tight m onetary policy. This econom ic contraction was brought about by a severe collapse in private investm ent (-57.8% ) and consum ption (-10.8% ). The public sector also experienced a sim ilar decline but at a lesser rate -fo r exam ple, public investment fell by 10% and consum ption by 7.8%. The reduction in private sector investm ent w as caused by a lack o f liquidity in the banking system due to the introduction o f a tighter monetary policy in late 1997. Prior to the crisis, credit grew on average about 28% annually betw een 1994 and 1996 and the Bank Negara M alaysia (the M alaysian central bank) introduced a credit plan to curb the ex cessiv e lending especially to the non­ productive sector such as real estate and loans to buy shares. In addition to a credit growth target o f 25% by year-end 1997 and 15% by year-end 1998, the plan also disallow ed credit for unproductive sectors. Higher interest rates added further pressure to the funding costs o f com panies and had caused an imm ediate slow dow n o f business activities. The M alaysian econom y began to recover in the second quarter o f 1999. This recovery cam e sooner than expected, with GDP registering a strong expansion o f 6.1% in 1999 and 8.3% in 2000. The revival o f dom estic consum ption, particularly from the public sector, contributed significantly to the recovery process. Aggregate consum ption expanded by 6.7% in 1998 and 10.5% in 1999. Public consum ption led this expansion with an increase o f 16.3% in 1999. Although the public sector pumped up its investm ent expenditure (11.7% ) in 1998, the total dom estic investm ent still declined (-5.9% ) due to the 18.5% contraction o f private sector investm ent. In 2000, there w as a significant improvem ent in dom estic investm ent, w hich grew by 25.7% , led by the private sector, which expanded its investm ent by 32.1% . H ow ever, private investm ent retreated once again (-20.6% ) under an adverse external environm ent in 2001. In contrast, public sector investm ent maintained an active role in leading the recovery with an increase o f 11.7% in 1999 and an even higher jum p o f 19.9% in 2000. In view o f the global econom ic slow dow n in 2001, public investm ent was expanded 15.5% to ensure that the M alaysian econom y did not enter into a recession again. It w as not surprising that the construction sector suffered the m ost during the crisis: the sector had over-invested during the period o f high growth (1987 to 1997), which resulted in a m assive excess capacity. This sector’s G DP shrank by 24% in 1998. The manufacturing sector also recorded a large decline o f 13.4%. On the other hand, the agriculture sector experienced a relatively m ild contraction (-4.5% ) w hile the services sector declined by -0.4% . The manufacturing sector was the engine o f recovery in 1999 and 2000. M alaysia benefited from the global recovery o f demand for sem iconductors, w hich had resulted in double­ digit growth for the manufacturing sector - 11.7% in 1999 and 19.1% in 2000. The construction sector only m anaged to grow marginally in 2000 (1%) after a dismal performance (-4.4% ) in 1999. 19 Table 4 Malaysia: Selected economic indicators, 1996-2002 1997 1998 1999 2000 10.0 7.3 -7.4 6.1 8.3 4.9 4.9 -10.3 6.7 10.5 5.8 8.8 6.9 Growth of GDP (%) 2001 2002 1996 Indicators/Year 4.3 -10.8 3.1 12.5 2.8 4.2 0.4 4.2 Growth by final demand category (%) Consumption (59.3) Private (45.6) 0.7 7.6 -7.8 16.3 3.0 17.6 13.8 9.7 8.4 -44.9 -5.9 25.7 -2.8 0.3 Private (34.2) 13.3 8.4 -57.8 -18.5 32.1 -20.6 -6.1 Public (12.6) 1.1 8.6 -10.0 11.7 19.9 15.5 4.6 4.5 0.7 -2.8 0.5 2.0 1.8 0.3 11.0 10.5 -6.5 5.4 14.21 -4.17 4.0 2.9 1.9 -0.4 6.9 1.9 1.6 4.5 Manufacturing (29.1) 18.2 10.1 -13.4 11.7 19.1 -6.2 4.1 Construction (4.4) 16.2 10.6 -24.0 -4.4 1.0 2.3 2.3 8.9 9.9 -0.4 4.5 5.7 5.7 4.5 Public (13.7) Gross domestic fixed investment (46.8) Growth by sector (%) Agriculture, forestry and fishing (9.8) Industry (41.5) Mining and quarrying (7.7) Services (48.7) Growth of manufacturing production(%) 12.2 12.4 -10.2 12.9 25.0 -6.6 4.5 Export-oriented (weight: 0.72) 11.0 13.2 -5.1 13.5 25.8 -10.4 5.1 Domestic-oriented (weight: 0.28) 15.6 10.4 -23.5 11.1 22.1 5.9 3.5 Imports of investments goods (growth of value) -6.5 17.1 -17.4 -9.9 38.6 -0.9 10.6 MIER manufacturing capacity utilization index 81.2 83.2 59.5 80.7 84.2 78.8 83.5 2.5 2.6 3.2 3.4 3.1 3.6 3.2 Consumer price 3.5 2.7 5.3 2.8 1.6 1.4 1.8 Producer price 2.3 2.7 10.7 -3.5 3.1 -5.0 4.4 Local goods 2.8 2.5 11.2 -3.9 3.6 -6.1 5.7 Imported goods 0.1 2.8 9.2 -0.6 1.1 -6.3 -0.7 Government expenditure as % of GDP 23.0 23.3 19.9 19.6 24.7 29.6 21.5 Gross development expenditure as % of total expenditure 25.1 24.0 31.9 38.5 33.1 35.6 46.9 0.7 2.4 -1.8 -3.2 -5.8 -5.5 -5.6 Total public debt as % of GDP 35.3 31.9 36.2 35.9 36.7 43.6 45.6 Foreign as % of total public debt (%) 11.7 14.4 14.5 16.6 15.0 16.7 21.9 M3 growth (%) 21.2 18.5 2.8 8.2 5.0 2.9 6.7 Annual average bank lending rate (%) 10.1 10.6 12.3 8.5 7.5 6.7 6.4 471 490 Unemployment rate Inflation rate (%) Fiscal performance (central government) 3 1 Budget surplus (central government) as % of GDP Money and credit (end of period) Outstanding loans of banking system (ringgit, billion) 325 586 482 672 454 Loans extended by the banking system (growth, %) 26.7 26.5 1.3 0.6 15.3 3.6 4.2 Manufacturing 14.8 18.5 2.0 1.3 3.5 0.2 -1.9 Property 26.8 34.0 6.9 -6.6 6.0 7.7 6.2 3-month classification 3.7 4.1 13.6 11.0 9.7 11.5 10.2 6-month classification - - 8.1 6.4 6.3 8.1 7.5 Non-performing loans as % of total bank lo a n sb / Share market performance KLSE composite index 1238 20 594 586 812 679.6 696 646 807 Market capitalization (ringgit, billion) 376 375 553 444 465 482 External transactions Merchandise exports (growth, %) 6.0 0.3 -6.9 15.7 17.0 -10.6 6.0 Merchandise imports (growth, %) 1.0 0.2 -25.9 12.5 26.2 -10.3 8.3 Current balance account as % of GDP -4.8 -5.3 13.0 15.9 9.3 8.3 7.6 Foreign reserves (US$, billion) 27.0 20.8 25.6 30.9 29.9 30.8 34.6 Total external debt as % GDP 38.7 43.9 42.6 42.1 46.1 50.7 51.7 Short-term foreign debt as % of total debt 25.7 25.2 19.9 14.3 11.1 13.7 17.2 Short-term foreign debt as % of foreign reserves 36.9 53.7 33.2 19.1 17.7 19.9 24.5 6.6 5.5 6.7 5.9 5.3 5.9 6.2 External debt service ratio ^ The sectoral share in expenditure and in GDP in 1996 is given in brackets. b/ Based on manufacturing production index (1993 = 100). - Data not available. - MIER: Malaysian Institute of Economic Research. iii. E xch a n g e rate At the onset o f the crisis, w hen regional currencies were under pressure to devalue, M alaysia tried to defend the ringgit but found this strategy unsustainable and costly. On July 14, the ringgit was floated and it depreciated sharply during the second half o f 1997 -th e ringgit exchange rate slipped from R M 2.50 per U S dollar to its low est level o f R M 4.88 on January 7, 1998. After show ing som e signs o f stability during February and March 1998, the ringgit, unlike the currencies o f the other crisis-hit econom ies, continued to deteriorate with a wide range o f volatility in the follow in g months until it was fixed at R M 3.80 per U S dollar on September 1998. The sharp depreciation and volatility o f the ringgit could be attributed to the large capital outflow and strong market reaction to M alaysia’s vocal stand on currency speculation. iv. E q u ity m a rket The equity market, not surprisingly, w as among the worst hit sectors in the crisis as the Kuala Lumpur Stock Market lost 80% o f its market valuation, betw een February 1997 and Septem ber 1998, when selective capital controls were im posed. In terms o f price/eam ings ratio, the Kuala Lumpur Stock Exchange C om posite Index (KLCI) dropped from 22.6 in June 1997 to 11.8 tw elve months later. The stock market slide was much earlier than the ringgit depreciation, beginning in February 1997. The credit plan issued by Bank Negara M alaysia (B N M ), which was concerned about the overheating econom y and large credit expansion to the property sector, had caused investors to sell their banking and property shares. B y late April, the KLCI had dropped by 10%. In August 1997, the B N M im posed a RM 2 m illion lim it on non-trade ringgit swaps to reduce currency speculation. A s a result, investors liquidated their holdings in the stock market and repatriated these proceeds. To stop the free fall o f its market, on August 1997, the KLSE made an unprecedented m ove, classifying the 100 stocks o f the KLCI as designated stock, w hich meant that investors had to have the scripts in their central depository account before they could be traded. The KLCI plum meted an additional 10% before the ruling was lifted on September 1997. 21 The governm ent also instituted other measures to shore up the stock market; for exam ple, it allow ed com panies to buy back their shares to overcom e steep share price deterioration. Concerns about the unsettled trading losses o f stockbroking houses also fuelled negative speculations and pushed the market downwards. The M alaysian stock market w as also characterized by the existence o f an active offshore securities market in Singapore, know n as central lim it order book international (CLOB). This over-the-counter market was created w hen the M alaysian government announced its plans to delist M alaysian com panies from the Singapore Stock Exchange in 1990. These CLOB shares were about 3% o f the total KLSE capitalization, as o f September 1998, and trade was carried out in Singapore dollars through Singapore brokers. Although the market stabilized in the first four months o f 1998, the stock market slide recom m enced after M ay and reached its bottom o f 262 points (an 80% drop) on September 1998, w hen the selective capital control w as introduced. The stock market rebounded strongly in 1999 -th e KLCI rose to a high o f 991 points on February 2000, but has declined since then. v. C u rren t a c c o u n t bala n ce During the initial phase o f the crisis, exports decreased as the troubled East Asian econom ies (50% o f M alaysia’s export market) m assively cut their demand for imports. In 1998, m erchandise exports decreased b y 6.9% (in US dollar terms) but actual export ringgit revenues increased because o f the steep currency depreciation. W hen the ringgit w as pegged (at R M 3.80 for one U S dollar), other regional currencies appreciated, increasing M alaysia’s relative price com petitiveness. This price com petitiveness allow ed M alaysian exporters to take advantage o f the robust U S export demand. In nom inal ringgit terms, total exports grew by 30%, with palm oil registering the highest increase o f 64% , follow ed by manufactured goods (32% ) and crude petroleum (6%). The large ringgit export revenue w as an important contributor to higher dom estic liquidity. M alaysia’s large merchandise balance o f U S $18 billion in 1998 w as achieved not only from large export proceeds but also from the collapse o f imports. Capital and intermediate goods dom inate the M alaysian import structure, with the latter for inputs for exports. In contrast, consum er goods only constitute about 10% o f total imports. Thus, when investm ent activities and export volum e dampened, the demand for imports also declined -merchandise imports decreased by 26%. D ue to the strong performance o f the merchandise account balance, the balance on goods and services reversed from the deficit trend that had prevailed during the 1990-97 period (on average about 5% o f GDP) into a surplus o f U S $12 billion in 1998. A s a result, the perennial current account deficits were transformed into a surplus o f 13% o f G DP in 1998. The trade balance registered an unprecedented surplus o f U S $19 billion in 1999. This surplus cam e from the 15.7% m erchandise export growth in 1999. Although imports also rebounded strongly (12.5% in 1999), a trade account surplus helped significantly to improve the current account position; the current account surplus reached a record level o f 15.9% o f G DP in 1999 and remained at a healthy 9.3% in 2000. Both exports and imports suffered substantial 22 reductions o f about 10% in 2001, but the current account surplus continued to record 8.3% o f GDP. vi. C apital flo w s Capital inflow s were important in financing the current account deficit as w ell as in generating new investm ents. Prior to 1993, capital inflow s into M alaysia m ainly took the form o f FD I but thereafter short-term capital, primarily portfolio flow s, also becam e significant. The large portfolio inflow in 1993 follow ed the regional pattern o f capital inflow s into local stock markets. After the A sian crisis, there w as a reduction in the FDI inflow into M alaysia -th e amount o f approved FD I declined from U S $9 billion in 1996 to U S $2.7 billion in 1998. In 1999 and 2000, the FD I inflow recovered to nearly U S $4 billion, but again dramatically declined in 2001 (to U S $0.6 billion). The slow ing dow n o f FDI inflow is due to both internal and external factors. The crisis has resulted in production over-capacity, thus discouraging new investm ents into the region. In addition, China tends to attract m ost o f the FD I inflow in the region. Unlike other crisis-hit econom ies, M alaysia has been cautious in promoting foreign purchases o f distressed assets from the crisis through mergers and acquisitions, and this has inhibited the opening o f another channel o f larger FD I inflow s. N ot unexpectedly, the short-term capital account show ed a substantial net outflow o f U S $5.7 billion in 1998 due to the decline in net external liabilities o f the com m ercial banks and the liquidation o f portfolio investm ents by foreign investors. The low er net external liabilities by com m ercial banks were in response to the stagnation in dom estic demand and the unwinding o f trade-related hedging activities. In fact the outflow had begun in 1997 (U S$4.6 billion) and it becam e larger in 1999 (U S $9.9 billion). To som e extent, this reflected the reluctance o f many foreign investors to return to the M alaysian market, because o f concerns about the re-im position o f regulations on capital flow s. In addition, investors were also uncertain about policy directions, especially on the issue o f the exchange rate peg. vii. F oreign reserves a n d extern a l d eb t The strong performance o f the external sector contributed to the improvement in the international reserves position. In August 1998, M alaysia had reserves o f U S $20 billion, w hich increased to U S$31 billion at year-end 1999, equipping the country to finance five months o f imports. H ow ever, the level o f international reserves did not change much in 2000 and 2001, even though M alaysia continued to record trade surpluses. This is partly explained by pre­ paym ents o f external debts and portfolio outflow s. M alaysia’s total external debt increased from 44% o f G DP in 1997 to 51% in 2001. This increase is attributed to higher long-term debt from both the public and private sectors. Public sector external debt is financed m ostly through sales o f sovereign bonds. In contrast, the share o f short-term foreign debt in total debt burden has been substantially reduced from 25% in 1997 to 14% in 2001. The international reserves were m ore than adequate to cover the short-term foreign debt -th e ratio o f short-term foreign debt to international reserves w as on average below 20% during the 1999-2001 period. 23 viii. Financial market The crisis placed a strain on the banking system . The high interest rate and collapse o f the stock market increased the non-perform ing loans (NPLs) o f financial institutions to a level considered seriously threatening. A s M alaysia had a very high ratio o f dom estic debt to G DP (152% ), the interest rate hike quickly turned many loans into NPLs. Prior to the crisis in 1997, the level o f NPLs at financial institutions was 4%, but by A ugust 1998, this figure had jum ped to 15.8%. The higher cost o f financing and tighter liquidity discouraged private investm ent. The cost o f funds for investm ent increased substantially when the base lending rate rose from 10.3% in June 1997 to 12.3% in July 1998: in som e cases, the effective interest rate reached a high o f 20%. 24 2. Policy responses for crisis resolution Concerning m acroeconom ic policies, the sw ift change in p olicy stance from tightening to easing supported the quick recovery o f the crisis-hit econom ies. In Korea, although fiscal and monetary policies differed in the points at which the policy stance changed (fiscal stim ulus first, monetary easing m ore cautiously), the policy target under the IMF program shifted from stabilization o f the foreign exchange market to econom ic recovery around April 1998. In M alaysia, although independent m acroeconom ic policies could be adopted from the beginning o f the crisis, counter­ cyclical p olicy measures only becam e fully effective from A ugust 1998 due to internal politics. The positive role o f counter-cyclical m acroeconom ic policies in the post-crisis recovery raises the question o f whether the initial tightening o f monetary and fiscal p olicy was kept high for too long, in effect deepening the crisis. In the case o f Korea, the IMF initially prescribed a tight monetary policy together with fiscal austerity. But, M alaysia also initially adopted the orthodox approach without IMF involvem ent. There is also the question o f whether the tight monetary and fiscal policy with or without the IM F involvem ent was inevitable in the early resolution o f the crisis. Radelet and Sachs (1998) asserted that the austerity m easures were unnecessary because the Asian crisis countries were suffering from a liquidity problem. They im plied that the traditional IMF p olicy prescriptions may have done m ore harm than good as they drove many highly leveraged but viable firms out o f business, thereby deepening the downturn o f the econom y. Feldstein (1998) further criticized the IMF for m oving beyond its traditional m acroeconom ic adjustment role by including a large number o f structural elem ents.14 The contribution o f initial IMF austerity programs and the presence o f structural elem ents in the IMF programs still remain controversial. H ow ever, it is generally agreed that the sw ift change toward a more expansionary m acroeconom ic p olicy stance helped these econom ies to recover quickly. a) P olicy responses in Korea i. E arly resolution The m acroeconom ic policy goals at the outset o f the IMF program for Korea had been to stabilize the foreign exchange market and build up foreign reserves through contractionary aggregate demand policies. In particular, the high interest rate p olicy prescribed b y the IMF for Korea and other Asian program countries has generated im m ense public and academ ic debates. Proponents argued that i) higher interest rates tend to slow capital outflow s by raising the nom inal return to investors from assets denom inated in the dom estic currency, ii) higher interest rates m ake speculation more expensive by raising the cost o f going short on the currency, iii) tight monetary policy reduces expectations o f future inflation and therefore o f future currency depreciation, and iv) monetary tightening - b y low ering expectations o f currency depreciation14 In the East Asian crisis countries that received IMF assistance, short-run policy goals were not necessarily consistent with medium-run structural reform objectives. A wide array o f reform packages would entail medium- or long-run development goals, which cannot be easily achieved in a short span of time. If pursued aggressively without due consideration of implementation difficulties and adjustment costs, even if desirable, structural reforms could delay economic recovery or would end up being perfunctory gestures (Park and Wang, 2002). 25 reduces default risk for those with unhedged foreign currency debt exposure (IMF, 2000). B y contrast, critics contended that although it m ay have been necessary to increase interest rates initially, they were kept high for too long, plunging the econom y into a vicious cycle o f declining output, increasing bankruptcies, and further w eakening o f the financial sector - a ll o f which served to weaken rather than shore-up investor confidence (Furman and Stiglitz, 1998). A number o f studies have tried to assess em pirically whether high interest rates have been useful in supporting the exchange rate. In general, the empirical evidence is inconclusive. During the early period o f crisis resolution, several other m easures were also sim ultaneously im plem ented to stabilize the exchange market. Tight m acroeconom ic policies were only one com ponent o f many. Thus, it is extrem ely difficult to single out the impact o f stringent m acroeconom ic p olicies on the exchange market. Additional p olicy measures included (i) the IM F’s financial support; (ii) maturity extension agreem ent with foreign creditors on restructuring short-term debt; (iii) accelerating capital account liberalization; and (iv) global bond issuance. This m ulti-pronged approach successfully restored external stability and allow ed foreign reserves to be rebuilt. ii. M a cro eco n o m ic p o lic y resp o n ses to the crisis From fiscal austerity to fiscal stimulus Prior to the crisis, fiscal p olicy in Korea had been based on a culture o f fiscal prudence, with the financial position o f the consolidated central governm ent remaining in balance since 1993. In fact, it has long been com m on practice in Korea not to undertake spending com m itm ents until the revenues that finance them have been received. During the 1990s, the government consistently reduced its sovereign indebtedness, w ith the central government debt falling to a low o f 9% o f GDP by 1996 (IMF, 2000, p. 56). In m ost o f the 1980s and 1990s, the fiscal stance did not m ove in a counter-cyclical w ay (Jun, 2002). W hen the crisis broke out, the initial IMF program presupposed that the policy o f fiscal conservatism should be continued. The original 1998 budget, passed on N ovem ber 1997 before the crisis becam e full blown, w as based on a forecasted real G D P growth rate o f 6% and targeted a budget surplus o f 0.25% o f G DP. B y early Decem ber 1997, how ever, growth estim ates had been downgraded to 3%. Under this revised m acroeconom ic outlook, the overall balance was expected to worsen to a deficit o f around 0.5% o f GDP. The objectives o f the IM F’s required fiscal balance were to support the monetary contraction in enhancing confidence in the exchange rate and to provide the funds necessary to rehabilitate the financial system . B y the end o f Decem ber 1997, the effects o f the crisis were becom ing more severe, prompting a reconsideration o f the initial fiscal p olicy response. Then, the program was revised to focus on allow ing automatic stabilizers to operate and tolerating a short-term deficit. H owever, greater fiscal stim ulus was programmed later. The supplementary budget w as im plem ented in March 1998, putting greater em phasis on increasing safety net spending, but this policy stance was still deem ed too tight given the worsening econom ic outlook. In the face o f a vicious spiral o f econom ic recession and corporate insolvency, counter-cyclical fiscal p olicy actions were strongly called for. A ccordingly, the fiscal p olicy stance w as changed toward expansion. Upon 26 consultation with the IMF, the target for consolidated budget deficits was adjusted upward from the initial 0.8% o f G DP (February 1998) to 1.75% (M ay 1998) and 4% (July 1998). In September 1998, the secondary supplementary budget w as im plem ented with expanded budget deficit target o f 5% o f GDP. H ow ever, the actual deficit for the year turned out to be 4.2% o f G DP because tax proceeds began to recover. The expansionary fiscal p olicy continued in 1999 in order to stimulate the econom y, support econom ic restructuring and increase spending for the social safety net. The budget deficit target was set at 4% o f G DP in 1999, and 70% o f the resources for public investm ent projects were front loaded in the first half o f the year. The deficit in 1999 was much smaller than the forecast because the econom ic recovery was stronger than expected. A s the econom y grew by a remarkable 10.7%, the fiscal deficit shrank to 2.7% o f GDP. B ecause o f the strong econom ic recovery, Korea reached again a fiscal surplus in 2000. K orea’s history o f fiscal soundness is what allow ed for these expansionary policy measures. K orea’s public debt as a percentage o f G DP stood at only 11% in 1997. A figure far low er than the average o f the O ECD countries o f about 70% (OECD, 2001). After the crisis, public debt as a percentage o f G DP jum ped to 16% in 1998 and 19% in 1999. From tightening to easing monetary policy Once the task o f stabilizing the foreign exchange market w as accom plished in early 1998, the stance o f the monetary p olicy w as progressively eased. In the second quarterly agreement (M ay 2, 1998), the IMF agreed to relax the pressures that were adversely affecting the dom estic credit crunch by low ering the high interest rates and resolving financial difficulties. H ow ever, continued caution w as warranted in view o f the unsettled global financial markets. B y June 1998, interest rates had been brought dow n to below the pre-crisis level. The relaxation o f the monetary p olicy continued in 1999. The short-term interest rate was further lowered to support a recovery in econom ic activity, with the overnight call rate falling below 5% in April 1999. The sustained low interest rate boosted stock prices, thereby facilitating econom ic restructuring and the reduction o f debt-to-equity ratios through new equity offerings. Exchange rate p olicy and capital market liberalization After Korea allow ed the w on to float on Decem ber 1997, the IMF requested that the Bank o f Korea refrain from intervening in the foreign exchange market, except in the event o f dramatic exchange rate fluctuations. W ith the floating exchange rate system in place, the Korean governm ent also substantially accelerated its ongoing capital account liberalization plan. Under the IMF program, the Korean governm ent agreed to undertake bold liberalization measures; in fact, the Korean government can be credited for m uch o f the initiative behind the reforms. A ll o f the capital markets, including the short-term m oney markets, were liberalized. But m ost importantly, the real estate market, w hich had been o ff lim its and considered non-negotiable, was com pletely opened to foreigners in the second quarterly agreement with the IMF (M ay 2, 1998). 27 N evertheless, a number o f regulations on capital outflow s o f residents still remain for the purpose o f preventing capital flight. For exam ple, • Institutional investors are permitted to hold deposits abroad for asset diversification purposes without a quantitative ceiling. But general corporations and individuals are permitted to hold deposits abroad o f up to $5 m illion and $50,000 a year, respectively; • The m onthly allow ance for residents staying abroad for over 30 days is $10,000. For those staying abroad over one year, a remittance o f $50,000 (including basic travel allow ances) is allowed; • R esidents traveling abroad may, in general, purchase foreign exchange up to the equivalent o f $10,000 a trip as their basic travel allowance; • The basic m onthly allow ance for students under 20 years old is $3,000; for students with a dependent fam ily, an additional allow ance o f $500 for a spouse and each child is allow ed. R esidents are allow ed to remit up to $5,000 a transaction to their parents and children livin g abroad for living expenses and to their relatives abroad for w edding gifts or funeral donations, with no restrictions on the number o f remittances; • R esidents may m ake paym ents abroad by credit card for expenditures relating to travel and tourism; for amounts exceeding $5,000 a month, the foreign exchange authorities must verify the authenticity o f the payments; • Loans by residents to nonresidents have to be approved by the M inistry o f Finance and Econom y; • For gifts, endowm ents, inheritance, and legacies, paym ents that exceed $ 5 ,0 0 0 have to be approved by the Governor o f the Bank o f Korea; • O verseas direct investm ent in the leasing and sale o f real estate, construction, and the operation o f g o lf courses are prohibited. N o approvals or notifications are required for acquisition o f overseas real estate by foreign exchange banks, government authorities, and residents if given as gifts or through inheritance from nonresidents. H ow ever, a notification to the B O K is required for the acquisition o f real estate necessary for approved business activities costing up to $10 m illion. For real estate necessary for approved business activities exceeding $10 m illion, perm ission from the BO K is required. Under a free floating system with free m obility o f capital flow s, the Korean won/dollar exchange rates m ight be expected to be excessively volatile. H ow ever, the Korean w on has exhibited an im pressive degree o f stability since the latter h alf o f 1998. A s the Korean won steadily appreciated in 1998-99, the Korean government continued to accumulate foreign reserves by intervening in the foreign exchange market. Hi. S tru ctu ra l reform m easures Structural reforms and restructuring measures have been actively carried out on two fronts: the financial sector and the corporate sector. 28 Financial sector The 1997-98 financial crisis demonstrated how Korea’s financial sector had failed to keep pace with both the developm ent o f the real econom y and Korea’s integration into the world financial markets. Restructuring o f the financial sector has been central to the structural reform program in Korea. A s a first step before starting sw ift and prudent financial reform s, the governm ent established an institutional and legal framework to coordinate and m onitor the reform process. The IMF also advised the Korean governm ent to im plem ent a plan for the closure o f nonviable financial institutions, w hich show ed no possibility o f being revam ped, and the rigorous restructuring o f others for rehabilitation. G ood progress has been made in consolidating the financial system and strengthening prudential regulations and supervision. During financial restructuring, public funds have been provided to ailing financial institutions. B y 1999, the Korean governm ent had m obilized fiscal resources o f 64 trillion w on, out o f w hich 44 trillion w on was used to recapitalize financial institutions, and the remaining 20 trillion w on was injected to support the disposal o f non­ performing loans (NPLs). The Korea A sset M anagement Com pany (K A M C O ) is in charge o f purchasing and recovering NPLs, w hile the Korea D eposit Insurance Com pany (KDIC) pays o ff deposits and recapitalizes financial institutions. W hen the second stage o f the financial restructuring program w as launched in September 2000, the initial plan to spend a total o f 64 trillion w on w as regarded as w h olly inadequate. Consequently, the government injected more public funds, amounting to 156 trillion w on in total by M ay 2002 (equivalent to nearly 30% o f G DP in 2001). To raise the m oney, K AM CO and the KDIC issued a total o f 104 trillion w on in restructuring bonds. The governm ent guarantees the repayment o f these bonds and pays the interest accruing on them from the budget. A n additional 20 trillion w on w as raised through other means, and the governm ent recycled som e recovered funds for additional u ses.15 A quarter o f the total funds was spent for the purchase o f N PL s, 39% for recapitalization, 27% for repayment o f deposits and other liabilities, and 10% for the purchase o f assets and subordinated debt (Jun, 2002). Although a great deal has been accom plished in restructuring and strengthening the financial sector in Korea, much more remains to be done. The IMF program did not consider the institutional and other constraints that could lim it the effectiven ess o f financial sector reform measures. W hen the crisis broke out, the bank-oriented financial system w as often blam ed for the crisis. The IMF program, therefore, included a capital market developm ent plan, in w hich capital markets com plem ent and substitute for the banking system as a source o f corporate financing. Although this plan is a reform objective, it can only be a long-term priority because the bankdominated system cannot be replaced by a market-oriented system overnight (Park, 2001, p. 37). Rapid dism antling o f the existing system (even flaw ed system ) could create an institutional void. 15 These include contributions from the public capital management fund, government property management special account, Bank of Korea account, and loans from the ADB and IBRD. 29 Corporate sector The high level o f corporate debt and w eak corporate governance in Korea resulted in the debt-financed expansion by business conglom erates, raising Korea’s vulnerability to the financial crisis. In the wake o f the crisis, the Korean governm ent m ade corporate restructuring a priority o f its reform agenda. In the corporate sector, relevant law s and institutions have been reorganized to enable a market-based corporate restructuring. H ow ever, the changes to the legal and regulatory framework w ould have little im m ediate effect on im proving com panies’ capital structure and profitability. The Korean governm ent actively intervened in pushing forward corporate debt restructuring. The governm ent decided to classify corporations into three tiers that mirrored the structure o f the Korean econom y. At the top w as the sm all cluster o f pow erful conglom erates, the so-called Top Five, that controlled a vast share o f the country’s productive and financial resources; next, a large group o f m edium -sized chaebols (ranked 6 to 64); and finally, SM Es. The government pushed the Top F ive to submit voluntary restructuring plans. The m ain banks were to review these plans and work with the chaebols to prepare final plans by D ecem ber 1998. The government also announced its proposal to use mergers and swaps am ong the Top Five to consolidate overlapping subsidiaries in key manufacturing industries (aircraft, autos, petrochem icals, pow er generation, rolling stock, sem iconductors and ship engines). For the second tier chaebols, the governm ent established an out-of-court workout schem e. The schem e w as m odeled along the Bank o f England’s London Approach.16 The governm ent set up several schem es to help SM Es obtain working capital and trade credit. M arket-led operational restructuring in tim es o f a system ic crisis is extrem ely difficult. In the case o f Korea, nearly all o f the corporations suffered from liquidity problem s. Reducing the debt-to-equity ratio is deem ed desirable, but it is unclear w hy the Korean government under the IMF program aim ed for such a drastic reduction in the corporate debt in such a short span o f time. The adoption o f the London R ules for corporate restructuring w as to som e extent understandable in the absence o f the market for bankruptcies and w ell-functioning court-based bankruptcy law s and institutions. In ou t-of court workout, the governm ent w as supposed to play the role o f mediator, facilitating an orderly debt resolution, and banks were supposed to act as creditors, m anaging the workout o f corporate debt; in m ost cases, how ever, the government dictated the process (Park, 2001). W hen a bank was recapitalized through the injection o f public funds, the government invariably controlled its management. The government-appointed bank managers were unw illing to change the status quo. They also had little incentive to collect overdue loans or to engage in 16 The London approach to corporate workout (out-of-court workout) differs from a court-supervised rehabilitation or receivership. The approach was taken because unlike the top-5 chaebols, most of the medium-size companies lacked access to bank credit or the capital markets and needed debt workouts or new loans to have any chance of meaningful restructuring. Preferential treatment was given in order to encourage banks to participate in the corporate restructuring process and to extend new loans to workout companies. However, it subsequently became clear that the lax provisioning requirement was a disincentive for banks to recognize true losses in debt workout cases and led to superficial corporate restructuring with debt rescheduling and long grace period. See Chopra et al. (2002) for more details. 30 workouts o f w eak but potentially viable corporate borrowers. The restructured banks have avoided corporate workouts as much as possible, so as not to increase their holdings o f N P L s or to low er their profits. This moral hazard problem has therefore delayed corporate restructuring and resulted in a deterioration o f bank asset quality (Park, 2001). b) P olicy responses in M alaysia17 i. E a rly responses A s with other affected countries in the region, M alaysia follow ed the orthodox approach to such a crisis, nam ely tightened fiscal and monetary p olicies, introduced measures to redress the balance o f paym ent weakness, and floated the exchange rate. This approach was adopted because the econom y w as thought to be overheated, thus the m ain objective w as to reduce excess demand. The governm ent had proposed a 3% surplus for the 1998 budget on October 1997. The budgetary measures introduced included a 2% reduction in governm ent expenditure, deferment o f m ega projects, and cutbacks on the government purchase o f foreign goods. On D ecem ber 1997, an additional package o f p olicy measures to further re-enforce the stabilization w as announced. These m easures were aimed at strengthening econom ic stability and instilling confidence in the financial system as the regional instability proved to be more protracted than was earlier anticipated. The package included a further 18% reduction in governm ent expenditure, strict approval requirements for new investm ents and deferment o f im plem entation o f non-strategic and non-essential projects. Regarding the financial aspects, a com prehensive set o f m easures w ere im plem ented such as reclassifying the non-performing loans (NPLs) in arrears from six to three months, greater financial disclosure by financial institutions and increasing general provisions to 1.5%. The reclassification o f the N PLs was aimed at adhering to international financial practices and ensuring an earlier warning o f the rising NPLs. The Bank Negara also raised the three-month intervention rate from 10% to 11%, increased the m inim um risk-weighted capital adequacy ratio from 8% to 10% for finance com panies and reduced the single custom er lim it from 30% to 25%. The lev e l o f provisions against uncollateralised loans w as also raised to 20%. In addition, m inim um capital for finance com panies w as increased from RM 5 m illion to R M 300 m illion and subsequently to R M 600 m illion. The capital adequacy framework w as also expanded to incorporate market risks. In view o f the tight liquidity in the system , the statutory reserve requirement was reduced from 13.5% to 10%. A s a measure to strengthen the balance o f paym ent position, a target w as set to reduce the current account deficit from 5% to 3% o f G DP in 1998 by lim iting imports and increasing import duties. Stricter criteria were also introduced for new overseas investm ents to reduce the outflow o f dom estic capital. 17 See Jomo (2001) and Mahani (2002) for two comprehensive analyses. 31 ii. Counter-cyclical m easures The implementation o f the stabilization policy did not im prove the econom ic situation. In fact, the econom y continued to contract, capital outflow worsened and the ringgit exchange rate remained volatile and depreciated. Rejecting the IMF type prescription, M alaysia reversed its earlier response policies and adopted counter-cyclical m easures to boost the dom estic econom y. This approach recom m ended the introduction o f fiscal stimulus, relaxation o f the monetary policy, and measures to ensure the stability o f the banking system as w ell as selective capital controls. H owever, due to internal differences am ong the top political leadership on the question o f crisis resolution, these measures only becam e fully effective in m id -1998. Fiscal stimulus programs W ith the reversal o f fiscal policy stance in m id-1998, an additional developm ent expenditure o f U S $1.8 billion w as allocated for agriculture, low and m edium -cost housing, education, health, infrastructure, rural developm ent and technology upgrading. The fiscal stimulus programs concentrated on infrastructure projects and an Infrastructure D evelopm ent Fund (U S $1.6 billion) was established to finance essential projects. Social support w as also given to the lower incom e group through direct transfers. These programs were aim ed at keeping dom estic activities going, particularly for small and m edium scale contractors and industries that were very dependent on government projects. The expansive policy fiscal turned the governm ent fiscal position from a 2.4% surplus in 1997 to a deficit. In 1998, the fiscal deficit was 1.8% o f G DP and it becam e larger subsequently to reach 5.8% in 2000 and 5.5% in 2001. These deficits were financed primarily from past savings, as the public debt level did not increase significantly during the 1998-2000 period (it hovered around 36% o f GDP). H ow ever, the M alaysian governm ent had to raise funds to continue with its fiscal expansion - in 2002 the ratio o f public debt to G DP jum ped to 46%. This 1R was m ainly financed from dom estic sources. The foreign share o f the total public debt had increased m arginally from 14.4% in 1997 to 16.7% in 2001. Easing the monetary stance A n important early measure was to increase liquidity and reduce the cost o f funds. In this regard, the statutory reserves requirement (SRR) was gradually reduced from 13.5% in February 1998 to 8% in July, 6% in September, and 4% in Decem ber 1998. W ith the reduction o f the SRR, an additional U S $10 b illion was injected into the banking system , w hich increased liquidity in the banking system, helping to overcom e the tight liquidity problem caused by the introduction o f the credit plan and cautious stance taken b y banking institutions. The initial response o f increasing the interest rate had seriously affected the business comm unity. In the first quarter o f 1998, the effective lending rate w as on average about 22%. Therefore, the imm ediate task w as to reduce the cost o f funds. The base lending rate (BLR) was reduced from a high o f 12.3% in June 1998 to 6.8% in October 1999. Lending rates were 18 Since the early 1990s, the public sector had attained a surplus budget. Thus, there were some savings that could be used to finance the deficit. In addition, Malaysia had a high savings rate (35% o f GDP) and a compulsory savings scheme where the government could access cheap financing. 32 consequently reduced from a high 24% in February 1998 to 7.9% in October 1999 and subsequently, in stages, to 6.4% in 2002. The low er borrowing costs and higher liquidity did not, however, produce high loan growth. Loan growth w as only 1% in 1998 and 1999 as compared to 27% in 1997. The lo w loan growth was due to both demand and supply factors: business conditions were still so lethargic for reviving new investm ents. M oreover, bankers were more cautious in extending loans to businesses. Selective capital controls A key p olicy response target w as to stabilize the ringgit. In September 1998, M alaysia im plem ented selective capital controls consisting o f tw o inter-related parts: stabilization o f the ringgit (w hich was pegged to R M 3.80/U S $1) and restrictions on the outflow o f short-term capital, which w as needed to ensure that the ringgit peg could be sustained. The m easures implemented to support the peg and control capital flow s w ere as follow s: • • • • • • • • A ll settlem ent o f exports and imports must be made in foreign currency; Travelers not allow ed to import and export ringgit exceeding R M 1,000 per person; Lim it on export o f foreign currency by resident travelers w as raised to R M 10,000; Residents are required to seek prior approval for remitting funds in excess o f RM 10,000 for overseas investm ent purposes; R esidents are permitted to obtain credit facilities in foreign currency up to the equivalent o f RM5 m illion. A ny amount exceeding the permitted lim it requires prior approval; R esidents are not allow ed to obtain credit facilities in ringgit from non-residents without prior approval; Proceeds in ringgit received by non-residents from the sale o f any securities must be retained in the external account and be converted into foreign currency after one year; and The ringgit is not legal tender outside M alaysia. The capital control measures affect the transfer o f funds am ong non-residents via non­ resident external accounts, the import and export o f ringgit by travelers (both residents and non­ residents) and investm ents abroad by M alaysian residents. Similarly, non-residents are proscribed from raising credit dom estically for the purchase o f shares. Non-resident portfolio investors are required to hold their investm ents for a m inim um o f tw elve m onths in M alaysia. H owever, capital controls do not im pede current account transactions (trade transactions for goods and services), repatriation o f interest, dividends, fees, com m issions and rental incom e from portfolio investm ents and other forms o f ringgit assets, and flo w s and outflow s (including incom e and capital gains). The selective capital controls were m odified on February 1999 with the quantitative control (the requirement stipulating that proceeds from the sale o f ringgit assets be kept in the country for one year) being replaced by a price-based regulation called an exit levy. The aim was to enable foreign short-term investors to estim ate the cost o f investm ent in M alaysia. This easing o f capital control consisted o f tw o parts: 33 For capital brought into M alaysia before February 1999, an exit levy w as im posed on the principal at the follow in g rates: □ □ □ □ 30% for a maturity period o f 7 months 20% for a maturity period o f 9 months 10% for a maturity period o f 12 months N o lev y w as charged on capital with a maturity period o f more than 12 months. For capital brought in after February 15, 1999, a levy w as im posed on the profits made at the follow ing rates: □ □ 30% for a maturity period o f less than 12 months 10% for a maturity period o f more than 12 months Although these relaxations were introduced, controlling the flow o f short-term capital was still the primary objective. A further relaxation was introduced in September 1999 on the exit levy - the tw o-tier system w as reduced to a flat rate o f 10% on profits repatriated. The exit levy was abolished on M ay 2001. Currently, the only remaining capital controls are the pegging o f the ringgit and the limitations on the outflow o f dom estic capital. Another measure that significantly affected portfolio investors was the requirement that all dealings in securities listed on the KLSE were to be affected only through the Kuala Lumpur Stock Exchange or through a stock exchange recognized by the M alaysian authority. Consequently, trading o f the 112 M alaysian com panies on the Central Lim it Order B ook (CLO B), the over-the-counter market o f M alaysian securities in Singapore, was discontinued by the Singapore Stock Exchange in Septem ber 1998. Ensuring the stability o f the banking sector B esides reviving econom ic activities, the M alaysian p olicy measures also focused on restoring the stability o f the banking sector. The core problem was the rising N PLs that had w eakened the capital base o f som e banking institutions. A s a result, these banking institutions were unable to perform their intermediary function, including extending loans for econom ic activities. Thus, in order to restore the stability o f the banking sector and to restructure corporate debt, the M alaysian government established three institutions, nam ely an asset management com pany to rem ove the NPLs, a recapitalization agency to inject new capital into the troubled banking institutions, and a corporate debt restructuring comm ittee. A n asset management com pany (Danaharta) was established in June 1998 to manage the NPLs o f financial institutions. Its m ain objective was to rem ove the NPLs from the balance sheets o f financial institutions at a fair market value and to m axim ize their recovery value. This would free the banks from the burden o f debts that had prevented them from providing loans to their customers. A s the capital base o f banks had been affected by the decline in share prices and NPLs, these banks needed to be recapitalized. For this purpose, a Special Purpose V ehicle (Danamodal) was set up in July 1998 to capitalize banks facing difficulties and especially to top-up their 34 capital, w hich w as reduced when Danaharta took over the NPLs. The injection o f capital was intended to enhance the resilience o f the banks and to increase their capacity to grant new loans so to speed up the econom ic recovery process. To com plem ent the restructuring o f the financial system by Danaharta and Danamodal, the Corporate D ebt Restructuring Com m ittee (CDRC) was set up in August 1998 to facilitate debt restructuring o f viable com panies, through voluntary solutions. The aims o f the restructuring exercise were to m inim ize losses to creditors, shareholders and other stockholders, to avoid placing viable com panies into liquidation or receivership, and to enable banking institutions to play a greater role in rehabilitating the corporate sector. The C D RC devised a market-approach debt-restructuring plan to enable creditors and debtors to solve their debts w ithout resorting to legal procedures. It also brought together all interested parties to assist in the corporate debt restructuring. The CDRC ceased its operations on July 2002. A s o f D ecem ber 2001, Danaharta had successfully disposed o f a total o f U S $13 billion in N PLs. In the process o f rem oving the N PLs, financial institutions had to share the losses -the average discount rate for NPLs w as 55%. Danamodal injected U S $2 billion into 10 financial institutions, pre-em pting any potential system ic risks to the financial sector. A s a result, the capital adequacy ratio o f the recapitalized financial institutions rose to 11.7% to becom e alm ost at par with the industry lev el (12.6% ). M ost o f the recapitalized institutions have repaid D anam odal’s capital injection. B y m id-2001, CDRC had taken on 75 cases, representing RM 47 b illion in debts, and had resolved 33 o f them, representing RM 28 billion. M alaysia has m oved to another stage in its banking sector restructuring - the 58 financial institutions have now been merged into 10 banking groups. Each o f the banking groups m ay offer a com plete range o f financial services such as merchant banking, fund m anagement and stockbroking services. Liberalization o f foreign direct investm ent R ealizing the contribution that foreign capital could make to the recovery o f the econom y, the M alaysian governm ent liberalized selected sectors in w hich it w as com fortable with foreign presence and in w hich it could m axim ize the gains from foreign capital injection. Thus, in the manufacturing sector, M alaysia relaxed its rules on equity ownership by allow ing 100% foreign ownership for investm ents made before the end o f Decem ber 2003. Previously, on ly com panies that fully exported their products were allow ed full foreign ownership. Equity liberalization was also carried out in other areas. M eanw hile, the 30% pre-crisis lim it on foreign ownership in the telecom m unications, stockbroking and insurance industries was raised to 61%, 49% , and 51%, respectively, although the lim it for the telecom m unications industry is scheduled to b e reduced to 49% after five years. In addition, foreigners are now permitted to purchase all types o f properties above R M 250,000 for new projects or for projects that are 50% com pleted to reduce ex cess real estate supply. Previously, there were restrictions on foreigners buying landed properties. 35 Corporate governance T o com plem ent the recovery measures, M alaysia also strengthened its corporate governance regim e. Although M alaysia had im plem ented m easures for good corporate governance practice, the crisis highlighted som e o f the shortfalls o f the existing regime. Additional measures were introduced in order to achieve im proved transparency and disclosure standards, more accountability o f com pany directors and protection o f minority shareholders’ rights, am ong other intermediate objectives. 36 3. Assessment of the adjustment processes in Korea and Malaysia Both Korea and M alaysia experienced the crisis starting in 1997. The exchange rate in both countries severely depreciated and the G DP growth rate plunged in 1998. Then they show ed a sharp V-shaped recovery. D espite this successful recovery, as explained in sections 1 and 2, the detailed measures they used to deal with the crisis were remarkably different. The main differences are summarized as follow s. First, w hile Korea sought IM F assistance im m ediately after the crisis and adopted the m acroeconom ic structural adjustment therapies prescribed by it, M alaysia refused to rely on the IMF and paved its ow n path to recovery. Second, w hile Korea liberalized its capital market more extensively after the crisis, M alaysia im posed capital controls instead; however, both retained or im posed som e restrictions on outflow s b y residents. Third, Korea’s exchange rate becam e, at least officially, com pletely floating, but M alaysia’s exchange rate was com pletely fixed, pegged to the U .S . dollar. Fourth, both countries used actively fiscal policy, m oving from a surplus before the crisis toward a significant deficit. Korea made a faster m ove into a m ild deficit in 1997 and to a large one, 4.2% o f G DP, in 1998. Interestingly, w ith the resulting recovery o f econom ic activity, the deficit w as reduced to 2.7% in 1999, and the balance returned to a surplus in 2000. M alaysia m oved m uch delayed into countercyclical fiscal p olicy in 1998 and subsequently has remained in deficit. Am ong the differences, the m ost striking ones are those related to capital controls and the exchange rate regime. In particular, it is the capital controls that allow ed M alaysia to maintain the fixed exchange rate and to start to reflate its econom y right away. H ence, m ost researchers have focused on the role that capital controls played in M alaysia’s recovery process. D espite these differences, rebounds o f both Korea and M alaysia were as drastic as their plunges. Park and L ee (2001) find that the im pressive recoveries have been faster than earlier episodes o f similar recoveries in other parts o f the w orld.19 W hile the growth rates in Korea and M alaysia som etim es diverge before 1997, they show a remarkably similar pattern from 1997 when the Asian crisis started. Both countries experienced the m ost severe recession in 1998, exactly one quarter apart: Korea’s low est growth rate was -8.1% in 1998 Q3 and M alaysia’s was -11.2% in 1998 Q 4. Thereafter, both countries rebounded quite rapidly so that the growth rates for the follow ing three quarters were -5.9% , 5.8% and 11.2% for Korea and -1.0% , 4.8% and 9.1% for M alaysia. The above findings indicate that, at least, the capital controls did not produce adverse results for M alaysia. H owever, a number o f researchers discount the role o f the capital controls in M alaysia’s recovery on the ground that Korea m anaged to recover without im posing capital controls. Krugman (1999), one o f the earliest proponents o f capital controls (Krugman, 1998), asserts that the financial panic w as com ing to an end just about the tim e that M alaysia decided to im pose the controls. N onetheless, he also states that “it w ould n ow be foolish to rule out controls as a measure o f last resort”. On the other hand, there are also a number o f studies show ing that M alaysia’s capital controls have been more successful than in other cases. K am insky and Schm ukler (2000) and 19 All the data in this section have been obtained from the Asian Recovery Information Center (http://aric.adb.org). 37 Edison and Reinhart (1999) find that in M alaysia the capital controls did produce the intended results o f greater interest rate and exchange rate stability and more p olicy autonomy. Kaplan and Rodrik (2001) go even further, asserting that the capital controls allow ed M alaysia a speedier recovery than w ould have been possible via the orthodox policies o f the IMF. This assessm ent crucially depends on the different tim ing they im pose on M alaysia’s recovery process. M ost other studies, exp licitly or im plicitly, assum e that the crisis and recovery occurred sim ultaneously in Korea and M alaysia. H ow ever, Kaplan and Rodrik argue that M alaysia’s situation at the tim e o f its capital controls w as m uch w orse than Korea’s. In fact, they claim that M alaysia’s im position o f capital controls could be view ed as the equivalent o f Korea’s appeal to the IMF for assistance. The difference in tim ing is about three quarters. B ecause M alaysia’s recovery process, w hich started w ith its introduction o f capital controls, w as superior to Korea’s, w hich started three quarters earlier, Kaplan and Rodrik conclude that the capital controls were more effective, eradicating M alaysia’s financial pressures so quickly that the country was able to recover at a faster rate than Korea. W hile Kaplan and Rodrik’s research is quite interesting, juxtaposing M alaysia’s recovery process three quarters later to K orea’s is disputable. In fact, Korea’s m inim um G DP growth rate leads M alaysia’s by just two quarters. M alaysia’s recovery process o f G DP lags behind Korea’s by one quarter. Further, w hile M alaysia bounces back more quickly (from -11.2% to -1.0% visà-vis -8.1% to -5.9% in Korea), its peak growth rate is low er than Korea’s. H ence, it is not evident w hich recovery process is unequivocally better. If w e exam ine the com ponents o f G DP in the recovery process, there are additional differences between Korea and M alaysia. Figure 1 show s changes in the share o f private consum ption and investm ent in G D P from 1996 Q1 to 2001 Q l. Panel A is the consumption share in G DP. A s im plicated by any standard theory o f consum ption sm oothing, the consumption share show s remarkable stability in both countries. H ow ever, the consum ption share is slightly low er in the crisis period. Panel B in Figure 1 show s that investm ent w as indeed m ost devastatingly affected by the crisis. In both countries the investm ent share drastically decreased during the recession and did not recover fully until 2001. A n interesting point to note is that w hile M alaysia’s investment share before the crisis was higher than Korea’s, it becom es slightly low er after the crisis. W e believe that this is closely related to the fact that M alaysia w as heavily dependent on FDI in the formation o f investm ent before the crisis, but FD I inflow s did not fully recover after the crisis. W e w ill return to this issue later in more detail. 38 Figure 1 Changes in GDP shares of expenditure components A. Consumption 70 r 96Q1 97Q1 98Q1 99Q1 00Q1 B. Investment 39 01Q1 02Q1 Figure 2 show s the growth rate o f com ponents o f G D P for both countries from 1996 Q1 to 2002 Q l. A gain w e can confirm from Panels A (consum ption) and B (investm ent) that the consum ption growth rate fluctuates much less than the investm ent growth rate in both countries. Panels C and D show the growth rates o f exports and imports. Interestingly the growth rate of imports fluctuates m ore than that o f exports in both countries. Further, the fact that growth of imports at the beginning o f the recovery remained negative in both countries, accom panied by a positive growth rate o f exports, seem s to have contributed to the recovery process. Figure 2 Growth rates of expenditure components A. Consumption 60 r 40 20 F C_g_K C a M -2 0 -4 0 f -6 0 B. Investment 60 40 I Lg_K Iq M 40 C. Exports EX_g_K Ex a M D. Imports 1 M_g_K IM a M Note: Due to the lack of quarterly data, all the series start from 1997 Q1 for Malaysia. Another important factor in the recovery process was monetary p olicy.20 W hile Korea initially m aintained a high interest rate as recom m ended by the IMF, its subsequent low ering o f the interest rate seem s to have helped the recovery process. Figure 3 shows monetary policy stances o f both countries in terms o f the three-month inter-bank lending rate. In Korea, the annualized lending rate jum ped from 15.5% in N ovem ber 1997 to 25% in D ecem ber 1997 and then rem ained above 16% until June 1998. Then, it fell to 12% in July 1998; subsequently, to 10%, and substantially low er afterwards. In M alaysia, the lending rate decreased to 9.5% in A ugust 1998, w hich is low er than the 12.3% average for the entire year 1998, but a more substantial decrease o f the interest rate im m ediately follow ed the capital controls in September 1998 and remained low er than 7% afterwards. 20 In general, however, Park and Lee (2001) find that monetary policy is less important than fiscal policy for post­ crisis recovery in 95 episodes o f crises during the period from 1970 to 1995. Figure 3 Monetary variables (three month inter-bank lending rate) Note: The available quarterly interest rate series for Malaysia starts from 1998 Q2 for Malaysia. In general, there w as concern that a sharp depreciation o f the dom estic currency w ould create inflation. H ow ever, for both Korea and M alaysia, the financial crisis led only to a small increase in inflation, w hich enabled both countries to adopt expansionary policies. Figure 4.A show s the inflation rates for both countries. During the crisis, the inflation rate w as slightly over 7% in Korea and it was m odest at around 5% in M alaysia. In particular, M alaysia’s inflation rate has further stabilized recently. The m ain factor that prevented the inflation rate from jum ping during the crisis w as the drastic fall in dom estic demand, particularly investm ent demand. Even during the recovery, both countries’ strong manufacturing sectors with excess capacity were able to m eet the higher demand without generating further inflation. Panel B in Figure 4 show s the change in the unem ploym ent rate in both countries. The unem ploym ent rate in M alaysia was not particularly high even during the crisis, partly because the large group o f immigrant workers in M alaysia at the tim e absorbed the severe impact o f the econom ic recession, causing many o f them to leave M alaysia for their hom e countries. In Korea, the financial crisis took a heavy toll on the labor market, but the labor market show ed significant flexibility in response to the crisis, both in term s o f prices and quantity. Faced with the collapse in demand in the w ake o f the crisis, firms slashed both w ages and em ploym ent. Nom inal w ages fell by an average o f 2.5% in 1998, or by 9% in real terms. The decline in nom inal w ages was the first since 1970. Layoffs were concentrated in SM Es where the highest rate o f bankruptcies was recorded, as w ell as in the financial sector. B y contrast, with few exceptions, chaebols did not undertake large-scale layoffs, although many reduced their workforces through voluntary separation and early retirement packages. U nem ploym ent in Korea, w hich averaged about 2.5% during 1990-97, rose sharply follow ing the crisis to peak at 8.7% in February 1999. The unem ploym ent problem was moderated by a significant decline in the labor force participation rate, m ainly as a result o f the 42 postponem ent o f job search by younger workers and a substantial withdrawal from the labor force b y discouraged fem ale workers. A s dramatic as the m ovem ent o f G DP w as the drop in the unem ploym ent rate to alm ost the pre-crisis level in the year 2002 (3.1%; see table 4). The fact that the crisis w as relatively short-lived, along with the existence o f a n ew ly and rapidly developed inform ation technology sector, in particular in the sm all and m edium -sized business sector, contributed to the rapid restoration o f the unem ploym ent rate. Figure 4 Inflation and unemployment rates A. Inflation rate B. Unemployment rate 8 - 43 S o far w e have found that, despite som e differences in details, M alaysia w as alm ost as successful as Korea in its econom ic recovery. W hile M alaysia chose to take the heterodox route by adopting capital controls, its recovery was remarkable. The capital controls on outflow s seem to have been successful. Further, as em phasized by “second-generation” m odels o f currency crises, even an econom y with strong fundamentals can face credit panic and a run on reserves due to a loss o f market confidence. In such cases, a temporary suspension o f capital outflow s can stop the run and elim inate the bad equilibrium. In the case o f M alaysia, the existence o f an active offshore securities and ringgit market provided an important and critical aspect o f the usefulness o f capital controls in managing a “second-generation” type o f crisis. A s show n by evidence o f pressures on the exchange rate, the ringgit continued to face severe pressure from January 1998 up to the tim e when the selective capital controls were introduced. On the other hand, the currencies o f the other crisis-hit econom ies had already stabilized by then. For capital controls to be successful, it is crucial for the crisis country to be fundam entally strong. If the crisis is due to fundamental problem s, then the second-generation m odels are not applicable and the crisis can end only when the fundamental problem s are elim inated. Then, w h y did Korea, w hich w as as fundam entally strong as M alaysia, not choose to follow the same route? W e b elieve that, w h ile capital controls were a tem pting choice for Korea, Korea m ay have worried about the possible side effects. Furthermore, Korea w as not free from the IM F’s advice under the IMF program. A s regards capital account liberalization, the Korean governm ent opted for a “big bang” approach by substantially accelerating its ongoing liberalization plan. In reference to the IMF program, one can say that the IMF is a veiled agent o f a W all Street-Treasury com p lex that is expanding its dom ain o f influence. Under the IMF program, the Korean governm ent agreed to undertake bold liberalization measures. In fact, the governm ent pursued a far more extensive capital market opening than what had been agreed upon with the IMF. The goal w as sim ply to stabilize the exchange market by attracting more foreign capital. Korea w as facing an increased demand for the liquidation o f foreign currency claim s. On the other hand, there w as little risk o f dom estic capital flight, because o f lim its on the ability o f dom estic residents to take capital out o f the country. 44 4. Policy implications The m acroeconom ic adjustment processes in both Korea and M alaysia have generally been consistent with the stylized cross-country pattern o f V-shaped recovery. H ow ever, the recovery has been far greater in Korea and M alaysia than in other crisis-hit countries. In this section w e discuss the p olicy im plications o f the experiences o f the tw o countries. First, the standard solutions are not the only effective w ays o f dealing with a crisis. In deciding on the appropriate response m easures, it is critical for policy makers to be fully cognizant o f the real causes o f the crisis and the initial dom estic conditions and capacity. Under som e circum stances, capital controls with an expansionary p olicy can be as effective as the standard solutions, at least in the short run. H ow ever, strong econom ic fundamentals are essential in enabling a country to choose different response measures. T hese fundamentals not only include all m acroeconom ic factors but industry-level factors as w ell. For exam ple, manufacturing industries must also be efficient in order to take advantage o f the recovery, the financial system m ust be w ell capitalized and supervised, and there must be sufficient dom estic sources o f funding. Under such circum stances, a country w ill be freer to ch oose the measures that best suit dom estic conditions since it w ill not be dependent on external financing. Second, the sw ift change toward an expansionary m acroeconom ic p olicy stance helped the tw o econom ies recover quickly. The positive role o f counter-cyclical m acroeconom ic policies in the post-crisis recovery, including fiscal and monetary p olicies, raises the question o f whether the initial monetary and fiscal tightening w as kept high for too long, and as a consequence deepened the crisis in Korea. In M alaysia, the expansionary monetary p olicy was essentially possible due to the capital controls. A p olicy o f a high interest rate to stabilize the exchange rate w ould have had serious im plications in M alaysia because o f the country’s large dom estic banking debt. Although M alaysia was less vulnerable to external shocks m ainly due to a more stable pattern o f capital m ovem ents (sm aller share o f short-term external debt), an expansionary monetary policy could not have been effectively im plem ented without the capital controls. Related to this, capital account liberalization should be properly sequenced and even som e controls on foreign debt may be necessary. Third, in both countries, a favorable external environm ent and more export-oriented econom ic structure helped the quick recoveries. A s the crisis was induced by the private sector, the dom estic private sector w as not a likely candidate to lead the recovery. A s a consequence, an expansionary fiscal p olicy played a leading role in the recovery o f econom ic activity in both econom ies. M aintaining a current account surplus also helped to boost dom estic demand and stabilize the exchange rate. Robust export growth propelled the strong recovery in the manufacturing sector. Since the manufacturing sector generated a large share o f G DP in both countries, it becam e the engine o f recovery. The resulting large trade surpluses also boosted international reserves, turning a negative current account balance into a positive one and injecting liquidity into the econom y. This trade surplus was useful for reviving consum er demand and financing recovery m easures, particularly during the early crisis period. 45 REFERENCES A gosin, M .R. (2001), “Korea and Taiwan in the financial crisis”, in R. Ffrench-D avis (ed.), F inancial C rises in S u ccessfu l E m erg in g E conom ies, EC LA C /Brookings Institution Press, W ashington, D.C. Athukorala, P. (2001), C risis a n d R e co very in M a la ysia : The R o le o f C apital C ontrols, Edward Elgar Publishing, Cheltenham. Borensztein, E. and J. L ee (2000), “Financial crisis and credit crunch in Korea: Evidence from firm -level data”, IM F W orking P a p e r 00-25, International M onetary Fund. Cerra, V. and S. C. Saxena (2003), “D id output recover from the A sian crisis?”, IM F W orking P a p e r No. 03-48, International M onetary Fund. Chopra, A ., K. Kang, M . Karasulu, H. Liang, H. M a, and A. Richards (2002), “From crisis to recovery in Korea: Strategy, achievem ents, and lesson s”, in D.T. Coe and S. K im (eds.), K orean C risis a n d R ecovery, International M onetary Fund and Korea Institute for International E conom ic Policy. Danaharta, A n n u a l R ep o rt, Kuala Lumpur, various issues. Edison, H. and C. Reinhart (1999), “Stopping hot m oney”, W orking P a p er, University o f Maryland. Feldstein, M . (1998), “R efocusing the IM F”, F o reig n A ffa irs 77, pp. 20-33. Furman, J. and J. E. Stiglitz (1998), “E conom ic crises: E vidence and insights from East A sia”, B rookings P a p ers on E co n o m ic A c tiv ity 2, pp. 1-136. International M onetary Fund (IMF) (2000), R e p u b lic o f K orea: D evelopm ent, IMF Staff Country Report N° 00/1 1 , February. E co n o m ic a n d P olicy Jom o, K. S. (2001) (ed.), M a la ysia n E clipse: E co n o m ic C risis a n d R ecovery, Zed B ook s Ltd., London. Jun, J. (2002), “Fiscal policy during and after the crisis in Korea”, paper presented at the International Conference on The K o rea n E conom y: B e y o n d the C risis, Seoul, October 4-5. Kaminsky, G. and S. Schm ukler (2000), “Short-lived or long-lasting? A new look at the effects o f capital controls”, in S. C ollins and D. Rodrik (eds.), B ro o kin g s T ra d e F orum 2000, The Brookings Institution, W ashington D.C. Kaplan, E. and D. Rodrik (2001), “Did the M alaysian capital controls work?”, N B E R W orking P a p e r N o. 8142, Cambridge, M ass. 47 Kim, S., S.H. Kim , and Y. W ang (2001), C apital A c c o u n t L ib era liza tio n a n d M acroeconom ic P erform ance: The C ase o f K orea, Policy A nalysis 01-01, Korea Institute for International Econom ic Policy. Krugman, P. (1999), “Capital control freaks - H ow M alaysia got away with econom ic heresy,” Slate, posted September 12. (1998), “Saving Asia: It’s tim e to get radical,” Fortune, issue date September 7. Mahani, Z. A. (2002), R ew ritin g the R ules: The M a laysian C risis M a n a g em en t M odel, Prentice Hall, Kuala Lumpur. M alaysia, Treasury E co n o m ic R ep o rt, M inistry o f Finance, Kuala Lumpur, various issues. OECD (2001), O E C D E co n o m ic O utlook, N o. 68, Organization for Econom ic Cooperation and D evelopm ent, June, Paris. Park, Y. (2001), “The East A sian dilemma: Restructuring out or growing out?”, E ssays in In tern a tio n a l E conom ics N° 223, Department o f E conom ics, Princeton University, Princeton, N ew Jersey. and J. L ee (2001), “R ecovery and sustainability in East A sia”, N B E R W orking P a p e r 8373, Cambridge, M A. , C. Chung, and Y. W ang (2001), “Fear o f floating: K orea’s exchange rate policy after the crisis”, Jo u rn a l o f the J a p a n ese a n d In tern a tio n a l E co n o m ies 15, pp. 225-251. and Y. W ang (2002), “W hat kind o f international financial architecture for an integrated world econom y?”, A sia n E co n o m ic P a p ers 1:1, pp. 91-128. Radelet, S. and J.D. Sachs (1998), “The East Asian financial crisis: D iagnosis, rem edies, prospects”, B ro o kin g s P a p ers on E co n o m ic A c tiv ity 1, pp. 1-74. Rodrik, D. and A. V elasco (2000), “Short-term capital flo w s”, A n n u a l W orld B a n k C onference on D evelo p m en t E co n o m ics 1999, W orld Bank, W ashington D.C. 48 Docum ents prepared within ECLAC research project on M a n a g em e n t o f Volatility, F in a n cia l G lobalization a n d G row th in E E s, supported by the Ford Foundation “M acroeconom ics-for-grow th under financial globalization: Four strategic issues for Latin Am erica” - Ricardo Ffrench-Davis Overcoming Latin A m erica’s growth frustrations: The macro and m esoeconom ic links” - José A ntonio Ocampo M acroeconom ic stability and investm ent allocation o f dom estic pension funds: The case o f Chile - Roberto Zahler Real m acroeconom ic stability and the capital account in Chile and Colombia - Ricardo Ffrench-D avis and Leonardo Villar The pro-cyclical impact o f B asle II on em erging markets and its political economy - Stephany Griffith-Jones and A vinash Persaud, with Stephen Spratt and M iguel Segoviano “Balance estructural del Gobierno Central de Chile: Análisis y propuestas” - Heriberto Tapia “Unem ploym ent, m acroeconom ic p olicy and labor market flexibility: Argentina and M exico in the 1990s” - Roberto Frenkel and Jaime Ros “E xchange rate regim es and m acroeconom ic performance: R evisiting three major Latin A m erican experiences” - Martín Grandes and H elm ut R eisen “Reform ing the global financial architecture: The potential o f regional institutions” - R oy Culpeper “M acroeconom ics and developm ent in South Africa” - Stephen Gelb “From the boom in capital inflow s to financial traps” - Roberto Frenkel “The conflict betw een purely-financial and real-econom y macrobalances: The case o f em erging econom ies since the 1990s” - Ricardo Ffrench-D avis “M acroeconom ics-for-grow th in em erging econom ies” - Ricardo Ffrench-D avis and Heriberto Tapia “The Chilean-style o f capital controls: An em pirical assessm ent” - Ricardo Ffrench-D avis and Heriberto Tapia “G lobalization in EEs” - Roberto B ouzas and Ricardo Ffrench-Davis 49